The domino effect

Monday, February 28, 2011
By Jonathon Pain
The Pain Report

PORTFOLIO POINT: Investors should be prepared for more instability in financial markets.

The tectonic plates of the Arab world have ruptured and the geopolitical fault lines that have shaped and defined the region for 60 years are shifting inexorably. We are witnessing a transformational phenomenon of spontaneous and populist revolt against repressive and corrupt regimes all across the region.

Over the last month we have seen a dramatic escalation of civil unrest in Libya where oil terminals are being liberated one by one and also Bahrain, where soldiers opened fire on thousands of demonstrators.

I lived in Bahrain for nine years and have studied the gulf region for 25 and it is my belief that what happens next in Bahrain will have profound ramifications for both the Middle East and the world and could well see Saudi Arabia and Iran drawn into the cauldron of recent events.

It is important to highlight that the uprising in Bahrain has a sectarian dimension in that we are seeing the Shia majority fighting for their rights in a land ruled by a Sunni Royal family. It is in Bahrain that we have seen the duplicity of British and American foreign policy, namely, the strategy of supporting stability at the expense of democracy.

Bahrain has for long punched well above its geographical weight in terms of its geopolitical significance as it is home to the US Navy’s fifth fleet, enabling America to be the de facto naval policeman of the Arabian Gulf and providing a launch pad for containment of Iran.

We should also remember that Bahrain, with its Shia population comprising 70% of the country, is a microcosm of the great divide in the Muslim world between Sunni and Shia. Let us be very clear that the Saudi Royal family do not wish to see the fall of the Al-Khalifa regime in Bahrain and for it to be replaced by a democratically elected Shia government. In recent days the Kingdom of Saudi Arabia issued the following statement, “The Kingdom of Saudi Arabia stands with all its capabilities behind the state and the brotherly people of Bahrain.”

In essence, this is thinly disguised code that if the Bahraini Royal family looks likely to be overthrown they will intervene, and given the two nations are joined by a causeway, the Saudi military could be in Manama in a very short period of time. That eventuality would put the Americans in a very difficult position, if not an impossible one. Could they stand idly by as Saudi troops shot the Shia protestors? Would Shia Iran not too get involved? Wouldn’t Ahmadinejad love to have a distraction from his own civil unrest and calls for democracy in Iran?

The Saudis watched with horror as the House of Mubarak fell in just 18 days. They were furious at America supporting the Facebook revolution in Tahrir Square and deserting their old friend and ally Hosni Mubarak. They tolerated American politicians talking about democracy on CNN, but never imagined that such a thing could happen in their own backyard.

When demonstrators gathered at the Pearl Roundabout to establish their own Tahrir Square in Manama, the capital of Bahrain, the authorities decided that the rebellion should be crushed immediately and at 3am on Thursday February 17, the security forces comprised of Sunni mercenaries from Pakistan and Syria were unleashed.

In the old days, before Twitter, Facebook and YouTube, such events in the middle of the night went largely unrecorded, but not this time. It did not take long for the phone call from the White House and it did not take too long for the Shia people in Bahrain to rise up and say enough is enough. It was at 3am that the Al Khalifa family gambled and lost its legitimacy in the eyes of the world and, more importantly, in the hearts and minds of the majority of its people.

It is not for me to speculate who made that fateful decision but sources suggest that it was the Prime Minister, the Uncle of the King, providing an ironic and Shakespearean twist to the tragedy at the Pearl Roundabout. Since then, the Crown Prince has been the most visible royal face, suggesting all is not cosy in the House of Al-Khalifa and that the Uncle may well have sealed the fate of the Al-Khalifa dynasty.

Over the last few decades, Middle Eastern analysts have constructed scenarios in which Bahrain featured prominently as a country vulnerable to significant unrest, given the sectarian divide and the repression of the Shia majority. The issue with Bahrain was that civil unrest in this tiny Kingdom could spill over to the wider region, due to its proximity to Saudi and the restive and similarly repressed Shia minority in the Eastern provinces, home to most of the Saudi’s oil fields. Furthermore, there was much speculation that Iran would be tempted to get involved given its longstanding contempt for the Saudi Royal family and its Wahhabi roots, which views Shia Muslims as heretics.

This in many intelligence circles suggested that Bahrain was a powder keg and that the USA, Saudi Arabia et all had a vested interest to ensure that no one got hold of a match with which to ignite it. Now that the powder keg has been lit it is particularly difficult to determine the ultimate outcome.

When the market is faced with such complex unknowns and the worst case scenario is no longer possible but probable, investors batten down the hatches. We then collectively attempt to build a new road map, but this, like every inflexion point in history, takes time. This is one of those moments.

The case for oil is a particularly compelling one and gold retains its allure as a sensible insurance policy. My opinion is that equity markets have commenced a correction which has further to run.

I have been mesmerised by the events in the Arab world over the last few months, and have no doubt that in decades to come we will look back and agree that those who stood in Tahrir Square and the Pearl Roundabout changed the course of history.

In summary, we appear, in the near term, to face a period of risk aversion after a prolonged period of impressive equity returns. Longer term I remain optimistic that the global economy will continue to be underwritten by the new locomotives in the East and that economics will prevail over politics.

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Jonathan Pain is the author and publisher of The Pain Report, offering independent and global perspectives of financial markets and the world economy.