^{EZEKIEL 25 17}

^{The path of the righteous man is beset on all sides by the iniquities of the selfish and the tyranny of evil men. Blessed is he who, in the name of charity and good will, shepherds the weak through the valley of the darkness. For he is truly his brother's keeper and the finder of lost children. And I will strike down upon thee with great vengeance and furious anger those who attempt to poison and destroy my brothers. And you will know I am the Lord when I lay my vengeance upon you.}

FSOC RUSSIA-CHINA REPORT

http://www.sectsco.org/home.asp?LanguageID=2

The Shanghai Cooperation Organization (SCO) is an intergovernmental international organization founded in Shanghai on 15 June 2001 by six countries: China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan. Its member states cover an area of over 30 million km2, or about three fifths of Eurasia, with a population of 1.455 billion, about a quarter of the world's total. Its working languages are Chinese and Russian. SCO's predecessor, the Shanghai Five mechanism, originated and grew from the endeavor by China, Russia,Iran, Kazakhstan, Kyrgyzstan and Tajikistan to strengthen confidence-building and disarmament in the border regions. In 1996 and 1997, their heads of state met in Shanghai and Moscow respectively and signed the Treaty on Deepening Military Trust in Border Regions and the Treaty on Reduction of Military Forces in Border Regions.On 19 November 2008 the SCO Secretary-General Bolat Nurgaliev met at the Secretariat with the Deputy Secretary-General of the Association of Southeast Asian Nations Soeung Rathchavy who arrived in Beijing for working consultations with the SCO. During the meeting B.Nurgaliev briefed the ASEAN official on main areas of the activity of the Organisation, the practice of SCO’s interaction with countries in the region and international organisations. S.Rathchavy described current goals and tasks concerning further deepening of integration among the 10 member states of the ASEAN. During the talks both sides expressed mutual intention to maintain regular contacts based on the MoU between the SCO and ASEAN signed in April 2005. Exchange of opinions took place over issues of regular interaction between the two organisations in such fields like economy and trade, transportation and communications, energy, environmental protection and sustained development, information technologies and their implementation. There after, this annual meeting became a regular practice and has been held alternately in the five member states. The topics of the meeting gradually extended from building up trust in the border regions to mutually beneficial cooperation in the political, security, diplomatic, economic, trade and other areas among the five states. The President of Uzbekistan was invited to the 2000 Dushanbe Summit as a guest of the host state. As the first meeting of the five heads of state took place in Shanghai, the cooperation mechanism was later known as the "Shanghai Five".

On the fifth anniversary of the Shanghai Five in June 2001, the heads of state of its members and the President of Uzbekistan met in Shanghai, the birthplace of the mechanism. First they signed a joint declaration admitting Uzbekistan as member of the Shanghai Five mechanism and then jointly issued the Declaration on the Establishment of the Shanghai Cooperation Organization. The document announced that for the purpose of upgrading the level of cooperation to more effectively seize opportunities and deal with new challenges and threats, the six states had decided to establish a Shanghai Cooperation Organization on the basis of the Shanghai Five mechanism. In June 2002, the heads of SCO member states met in St. Petersburg and signed the SCO Charter, which clearly expounded the SCO purposes and principles, organizational structure, form of operation, cooperation, orientation and external relations, marking the actual establishment of this new organization in the sense of international law.

Iran appears increasingly interested in joining the Shanghai Cooperation Organization (SCO) and form a powerful axis with its twin pillars, China and Russia, as a counterweight to a US power "unchained". The SCO was initially set up as an open and nonaligned organization and it was not initially targeted at a third party. Chinese Assistant Foreign Minister Li Hui said that the Shanghai Cooperation Organization (SCO) will not take in new members before its six members make serious studies. The organization is still very young and the six SCO members need to have further discussions before deciding whether or not to accept new members, Li said 01 June 2004. Mongolia's demand to participate in the organization as an 'observer' was approved at the June 2004 summit. Guidelines on the status of observer nations were approved and it was decided to award Mongolia this new status.

On 17 June 2004, the Shanghai Cooperation Organization held its annual Summit in Tashkent, Uzbekistan. Attending this conference was Chinese President Hu Jintao, Russian President Vladimir Putin, Kyrgyzstan President Askar Akayev, Tajikistan President Emomali Rakhmonov, Kazakhstan President Nursultan Nazarbayev and Uzbekistan President Islam Karimov. Much of the pre-summit media attention included what Russian President Putin and Chinese President Hu hoped would facilitate the development of economic relations between the SCO countries. This appeared to have been successful. At the conclusion of the summit, the leaders signed a document titled the Tashkent Declaration. The declaration summarized the outcome of the SCO's work since it was set up, evaluated the activities of the organization's agencies and set new goals. They also signed agreements on cooperation in fighting drug trafficking and on the protection of secret information in the framework of the SCO anti-terrorist agency, whose headquarters were opened in Tashkent.

Several meetings were conducted on the sidelines of the Summit. Chinese President Hu Jintao met with Afghanistan Transitional President Hamid Karzai, who was a guest of Uzbek President Islam Karimov, and they discussed Afghanistan’s attempts to locate and bring to justice the terrorists who attacked Chinese workers there. In other meetings, Kyrgyz President Askar Akayev handed over to Hu Jintao a written document to confirm Kyrgyzstan's stance to recognize China' s full market economy status. Hu said the move by Kyrgyzstan will "greatly push forward China-Kyrgyzstan bilateral trade and economic cooperation." Hu made a four-point proposal in meeting with Tajik President Emomali Rakhmonov on strengthening cooperation. Hu said the two sides should support each other on major issues, enhance law-enforcement cooperation to fight against terrorism, separatism and extremism, as well improve economic relations and cultural exchanges. Rakhmonov said he agreed with Hu's proposals. Kazakh President Nursultan Nazarbayev visited China last month and the two sides signed a number of agreements to cement cooperation primarily in oil and natural gas as well as in other areas. Russia and Uzbekistan signed a strategic-partnership treaty, with Russian President Vladimir Putin and Uzbek President Islam Karimov hailing it as a new stage in long-term relations.



April 8, 2008 Introduction What is the history of the SCO? What is the SCO position on the U.S. presence in the region? What was the SCO’s role in removing U.S. forces from Uzbekistan? How strong is the SCO’s presence in the region? What is the status of Iran’s efforts to join the SCO? What are the pros and cons of Iran joining the SCO? What are Iran’s motivations for joining the SCO? Is Iran’s desire to join the SCO aimed at the United States?

Introduction

The Shanghai Cooperation Organization (SCO)–comprised of China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan–began in 2001 as a confidence-building mechanism to resolve border disputes. In recent years, it has risen in stature and scope, making headlines in 2005 when it issued a timeline for U.S. forces to pull out of Uzbekistan. Some experts say the organization has emerged as a powerful anti-U.S. bulwark in the region, while others say that because of inherent frictions between its two main members, Russia and China, the SCO is unlikely to pose a threat to U.S. interests in Central Asia. Meanwhile, talks are under way to amend the group’s mission statement to include, among other things, increased military cooperation, intelligence sharing, and counterterrorism drills. Iran is currently one of four observers to the SCO. It requested full membership in March, prompting speculation about the future direction of the SCO.

What is the history of the SCO?

Originally called the Shanghai Five, the SCO formed in 1996 largely to demilitarize the border between China and the former Soviet Union. In 2001, the organization added Uzbekistan and renamed itself the Shanghai Cooperation Organization. Mongolia won observer status in 2004; Iran, Pakistan, and India became observers the following year. The SCO has since risen in regional prominence, tackling issues of trade, counterterrorism, and drug trafficking. Unlike the North Atlantic Treaty Organization (NATO), the organization is not a mutual defense pact. But the SCO has held a number of joint military exercises, most recently in 2007 near Russia’s Ural Mountains. Some experts cite a convergence of interests among members in recent years, including improved ties between China and Russia and the perceived threat posed by U.S. forces in the region. Others, including Lieutenant General William E. Odom, senior fellow at the Hudson Institute, say the SCO is being used by Russia and China as a vehicle to assert their influence in Central Asia and curb U.S. access to the region’s vast energy supplies.

What is the SCO position on the U.S. presence in the region?

SCO members say U.S. bases in the region, established in the wake of 9/11, were not meant to be permanent and were only installed to assist the U.S.-led war in Afghanistan. China and Russia have chafed at the U.S. military presence in Central Asia, an energy-rich region both consider within their sphere of influence. After uprisings in Ukraine, Georgia, and Kyrgyzstan unseated leaders loyal to the Kremlin, Russia has viewed the U.S. presence in post-Soviet states with increasing suspicion. Many in Moscow argue the so-called color revolutions were the work of U.S.-funded nongovernmental organizations. Beijing sees the U.S. military presence along its western border as part of Washington’s strategy to contain China, experts say.

What was the SCO’s role in removing U.S. forces from Uzbekistan? On July 5, 2005, the SCO issued a declaration implicitly calling for the United States to set a timeline for withdrawing its military forces from Karshi-Khanabad Air Base, located in southern Uzbekistan. But experts say relations between Uzbekistan and Washington were already on the skids. After 9/11, Uzbekistan became a strategic partner of the United States, cooperating with American forces on counterterrorism issues and allowing use of the Karshi-Khanabad air base. In return, Uzbekistan received security guarantees and military equipment. Yet a May 2005 uprising in Andijan province, followed by a brutal crackdown by the Uzbek authorities, led to sharp criticisms from Washington. The Uzbek government also grew suspicious of U.S. involvement in pro-democracy revolutions in Georgia, Ukraine, and Kyrgyzstan. Hence, the Uzbek government ended its military cooperation with the United States and moved to eject U.S. forces from Karshi-Khandabad. The SCO declaration, most experts say, merely accelerated the withdrawal of U.S. forces, which was completed by the end of 2005.

How strong is the SCO’s presence in the region?

Not that strong, but growing, most experts say. “The basic picture is the SCO is not as important as people in Washington think,” says Daniel Kimmage, an expert on Central Asia at Radio Free Europe/Radio Liberty. The SCO serves more as a forum to discuss issues of trade and security than a fully-developed counterpoint to NATO. “If you take NATO as your standard for organizational effectiveness,” Kimmage says, “the SCO is not even close yet.” Plus, unlike NATO, there are no mutual defense pledges. Also holding back the organization’s effectiveness are internal divisions and tensions between its member states, particularly China and Russia over issues of energy and the construction of ports in the region. Finally, multilateral institutions historically have a poor track record in the region. “Most countries do serious stuff bilaterally,” Kimmage says. That said, most experts agree that the SCO’s influence in the region is on the rise. “I think the current fears [of Iran joining] are overblown but that doesn’t mean the capacity isn’t there,” says Martha Brill Olcott, a senior associate with the Carnegie Endowment for International Peace. Others say a stronger SCO, particularly one with a military component and Iran as a full member, might serve as a check to U.S. interests and ambitions in the region. “An expanded SCO would control a large part of the world’s oil and gas reserves and nuclear arsenal,” David Wall, an expert on the region at the University of Cambridge’s East Asia Institute, told the Washington Times. “It would essentially be an OPEC with bombs.”

What is the status of Iran’s efforts to join the SCO?

Since Iranian President Mahmoud Ahmadinejad attended the Shanghai summit in 2006, there has been speculation that Iran might join the SCO. In March 2008, Iran’s Foreign Minister Manouchehr Mottaki officially announced Iran’s bid, saying Tehran had submitted a request for full membership to the SCO Secretariat. As of now, there is no clear mechanism in place to expand the SCO and offer Iran—or any other potential member—formal membership.

What are the pros and cons of Iran joining the SCO?

Sergey Karaganov, chairman of the Russia-based Foreign and Defense Policy Council, says eventual membership could “be one of the carrots that [is] part of a larger deal” to resolve the current nuclear crisis with Iran. Also, membership “would allow China and Russia to influence more positively Iran’s foreign policy and, by implication, the Muslim world,” writes Kaveh Afrasiabi, an expert on Iran, in the Asia Times. Yet other analysts are more skeptical. “At a certain point it’ll become so diluted that China’s original interest [in the SCO]—to neutralize its western neighbors—will not have been lost but submerged amid other issues,” says S. Frederick Starr, an expert on Central Asia at Johns Hopkins University. Another problem is “nobody will trust the Iranians,” Olcott says. “[SCO members] may be cutting off their noses to spite their faces,” she says. “If they want to score geopolitical verbal punching points, it's a good move. But if you want it to function better, you get nothing by bringing in Iran.” RFL/RL reports that China and Russia are wary of making Iran a full member on the grounds that Iranian membership could give the SCO more of an anti-American tone.

What are Iran’s motivations for joining the SCO?

In addition to a means for Iran to tighten its contacts with Russia, experts say Iran sees the SCO as a club of like-minded states important to its geostrategic interests in Central Asia. The SCO also complements Iran’s so-called “looking East” foreign policy, says Mohsen Sazegara, an Iranian dissident, policy activist, and former professor at Yale University. He says Iran has strong historical, cultural, and economic ties with many of the Central Asian countries. Iran also wants to cultivate a stronger relationship with larger states like India and China. “China gets a lot of energy from Iran and in the future wants to get more,” Starr says. But some experts question Tehran’s “Eastern” orientation. “I think as it becomes exposed and analyzed, [it] will prove to be more of a slogan than a policy,” said CFR Senior Fellow Ray Takeyh at a Middle East Policy Council Forum.

Is Iran’s desire to join the SCO aimed at the United States?

Perhaps, experts say. “Part of Iran’s foreign policy, at least in the mind of the Supreme Leader, is to be anti-U.S.,” Sazegara says. Further, Iran views the SCO as a potential guarantor of future security, experts say. Membership, for example, could offer Iran shelter from the international pressure put on Tehran to end its uranium-enrichment program. Similar protection was provided to Uzbekistan after the Andijan massacre in May 2005.

(SCO=NEW GLOBAL GAS MAFIA & AXIS OF EVIL)

''Russia-China Security Cooperation Organization-AKA-GLOBAL GAS MAFIA'' Russia and China have joined together in a strategic partnership aimed at countering the U.S. and Western "monopoly in world affairs," as was made clear in a joint statement released by the Chinese and Russian presidents in July 2005. The long standing border disputes between the two countries were settled in agreements in 2005, and joint military exercises were carried out in the same year. Furthermore, Russia, in addition to its arms exports, has been increasing its oil and gas commitments to China. Clearly, the recent comprehensive improvement of bilateral relations between China and Russia is a remarkable development. What is the meaning of this military and security related cooperation, and is the Sino-Russian military liaison likely to expand? Should this rapprochement be considered as a structural shift of power with the goal of repelling Western influence from Central Asia and the adjacent areas?

Russian-Chinese Military Maneuvers

In August 2005, for the first time in 40 years, Russian and Chinese armed forces carried out joint military exercises. China took the lead in proposing the size, participating type of forces and content of the maneuvers. Allegedly, China also took care of most of the costs of the exercises. The formal objectives of the mission were to strengthen the capability of joint operations and the exchange of experience; to establish methods of organizing cooperation in the fight against international terrorism, separatism and extremism; and to enhance mutual combat readiness against newly developing threats. [See: "The Significance of Sino-Russian Military Exercises"] The exercises comprised "ingredients" such as the use of strategic long range bombers, neutralization of anti-aircraft defenses, command posts and airbases, gaining air superiority, enforcing a maritime blockade and the control of maritime territory. Terrorist movements, however, do not posses conventional land, sea or air forces, nor do they deploy their military power in a symmetrical way. Therefore, the objectives of the joint exercises had little to do with combating terrorism; instead, they were aimed at conventional warfare, employing all military services except for nuclear forces. The actual objective of the maneuvers was likely to display to the Western world that Russia and China consider themselves to be in control of the Asia-Pacific region and that outside powers will be denied the right to interfere in their sphere of influence. From a military-operational point of view, Russia as well as China gained from the experience of the bilateral exercises. The Chinese armed forces are -- as a consequence of China's increasing political and economic power -- in a stage of growth, in size as well as in ambition. Therefore, practicing command and control procedures but also purely operational aspects, such as carrying out an airborne assault, will strengthen the capabilities of the Chinese forces. If Russia considers that China might turn into a threat in the long run, then these exercises have also been worthwhile for the Russian general staff by providing it insight into how the Chinese armed forces operate and what their current capabilities are.

Arms Sales

The demonstration of weapon systems at the 2005 Sino-Russian exercises might have been meant to promote Russian arms sales to observers of the Shanghai Cooperation Organization (S.C.O.). India, for instance, comprises some 40 percent of Russia's arms exports and Iran is considered to be an important growth market for the Russian arms market. Currently, some 45 percent of Russia's arms exports go to China. Since 2000, Russia has delivered weapon systems to China -- including fighter aircraft, submarines and destroyers -- amounting to an average of US$2 billion annually. China has been the largest consumer of Russian military equipment for a number of years. Russia's arms trade to China is an important factor in the cooperation between the two countries. Nevertheless, Russia seems to be well aware that China would like to obtain its most sophisticated military technology, which, in case of deteriorating relations, Beijing might use against Russia. For that reason, Russia is reluctant to provide China with its state-of-the-art products. Moreover, there are indications that China is steadily acquiring enough knowledge to have a solid military industry of its own. Subsequently, in the coming years China will buy fewer arms from Russia, which will diminish the value of this cornerstone of their bilateral relationship.

Energy Policy

In August 2005, during a visit to Beijing, Russian President Vladimir Putin stressed economic ties and especially the work of Russian energy companies in China, bilateral projects that would distribute those supplies to third countries, as well as the delivery of Russian oil and gas to China. Furthermore, in November 2005 Russia and China agreed to double oil exports to China and to consider constructing an oil pipeline from Russia to China and a gas-transmission project from eastern Siberia to China's Far East. China, however, also focuses on Kazakhstan in its need for energy. In December 2005, the Atasu-Alashankou pipeline between the two countries was opened. In due course, this Sino-Kazakh pipeline will be enlarged from 1,000 to 3,000 kilometers (621 to 1,864 miles) and will eventually provide China with approximately 15 percent of its crude oil needs. By establishing energy ties with Kazakhstan, it is clear that China wants to avoid energy dependency on Russia. Another argument is that by redirecting Kazakh oil pipelines through China instead of through Russia, China's influence over Kazakhstan and Central Asia will increase at the expense of Russia's position. Thus, Russia's energy power tool -- as used successfully against Ukraine -- seems to be threatened by China's energy strategy. Although cooperating with China in energy, however, Kazakhstan has a considerable Russian minority and therefore will be unlikely to follow an anti-Russian political course.

The Demographics Factor

In December 2005, Russia's interior minister, Rashid Nurgaliev, stated that illegal immigration is creating a threat to national security in the Russian Far East. Although Nurgaliev did not mention the word "Chinese," and in spite of frequent formal statements contradicting such a development, a continuous influx of illegal Chinese immigrants is taking place in this region. Russia has a long border with China, some 4,300 kilometers (2,672 miles), and is sparsely populated in its Far East. The numbers may vary but sources mention a flood of thousands of Chinese entering Russia, up to allegedly 600,000 per year. It is not inconceivable that this flood is more than a coincidence; in fact, it might well be a planned policy directed from Beijing. Possibly, China is carrying out a policy of "Finlandization" in order to gradually increase its influence over this Russian region. The reasons for such a population policy might be to create an overflow area for Chinese citizens from densely populated areas in China proper, and also to gain a political and/or economic foothold in this area, which is rich in energy resources.

The Shanghai Cooperation Organization

The Russian-Chinese military exercises of 2005 should not only be considered from a Sino-Russian bilateral point of view, but also as an activity of the S.C.O., as was frequently stated by Russian Defense Minister Sergei Ivanov. Not only did the Russian and Chinese ministers of defense observe the maneuvers, but also present were representatives from the S.C.O. Formed in 1996 as the "Shanghai Five" -- comprising Russia, China, Kazakhstan, Tajikistan and Kyrgyzstan -- in 2001, together with admitting Uzbekistan, the S.C.O. was formalized as an international organization. Until 2005, the S.C.O. mainly dealt with regional security -- in particular against the three "evils" of terrorism, separatism and extremism -- as well as with economic cooperation. However, at its summit of July 2005 in Astana, the S.C.O. proclaimed a radical change of course. The governments of the Central Asian member states -- faced with the Western-supported regime changes in Ukraine and Georgia, as well as with Western criticism of the Uzbek government's repression of the unrest in Andijan -- increasingly saw their existence threatened, which forced them to choose an alliance with Russia and China and diminishing the (economically favorable) relationship with the West. [See: "Intelligence Brief: Russia in the S.C.O."] At the summit, this led to a final statement of the S.C.O. members in which Washington's unipolar and dominating policies as well as foreign military deployment in Central Asia were condemned and the withdrawal of Western military troops was encouraged. This Declaration of the Heads of Member States revealed a watershed in the S.C.O.'s range of policy from regional anti-terrorist activities to claiming an important position in the international arena in external security policy. In addition to the S.C.O.'s change of course, there was another significant development at the 2005 summit. In addition to Mongolia, in July 2005 Iran, Pakistan and India joined the S.C.O. as observers. By admitting these three states as observers, the S.C.O. now encompasses nearly half of the world's population. Furthermore, in addition to Russia and China, India and Pakistan bring together four nuclear powers, whereas Iran possibly has the ambition to become one. In addition to this, the S.C.O. Shanghai summit of June 2006 -- which was dominated by energy deals, especially by China -- demonstrated that energy resources (Russia, Kazakhstan and Iran) are also a crucial focal point for its members and observers. Comprising a considerable territory in and around Central Asia, a large part of the world population, energy resources and nuclear arms, the S.C.O. has a formidable political, economic and military potential. For Russia, the S.C.O. apparently acts as a means to bring together different policy objectives. Not only China, but India and Iran as well have a special relationship with Russia. All three states are important actors in Russia's arms exports. In addition to this, China and India are gaining a closer relationship with Russia in the field of joint, bilateral military exercises. Therefore, the fact that India and Iran recently joined China in its cooperation with Russia within the S.C.O. could prove that the S.C.O. serves as a platform for Russia's security policy. It is evident that the S.C.O. is gaining power, in particular since the Astana summit of 2005. It is likely that this development of the S.C.O. will continue in the coming years. Russia will use this organization to reduce Western and U.S. influence in Central Asia which was accomplished in the aftermath of the September 11 attacks. In such a way, the S.C.O. will represent to Russia a vital instrument to achieve geopolitical objectives. In envisaging the future position of the S.C.O., it is important to note that cooperation among its members and observers is essentially based upon a negative strategic objective: to counter U.S. and Western influence. To a large extent, common, positive targets are absent. For example, China is seeking markets and energy resources; Russia is eager to regain its leadership status within the C.I.S. as well as that of a superpower in the international arena; and the Central Asian regimes consider the S.C.O. as their guarantee for political survival. Moreover, India and Pakistan are probably showing the West that they follow their own independent course and Iran's objective might be found in anti-Americanism. This mixture of possibly divergent objectives -- for instance, Iran's support of radical Islamists which are a threat to the Central Asian states -- demonstrates that they do not necessarily have much in common. It is not inconceivable, therefore, that the eventually deviating objectives of the S.C.O. member states and observers will cause a split in the organization, which would paralyze its activities.

Outlook on Russia-China Relations

In the coming years, Russia is likely to strengthen its ties with China. These two states are seeking a closer relationship not only in the field of security, but also in areas such as military cooperation, energy, the arms trade and foreign policy. Russia has more than once stated that closer relations with China is a geopolitical objective in order to strengthen Russia's global position. Nonetheless, this close relationship with China could very well turn out to be for the short term. In its Far East, Russia is increasingly confronted with illegal immigration from China. Furthermore, Russia possesses energy resources that China desperately needs. China is "using" Russia for its military technology and energy resources. When China reaches its current drive for independence in military technology and will have created alternative ways of gaining energy -- for instance through Kazakhstan -- China may reduce ties with Russia. Moreover, China will continue to use its neighbors, such as Russia, the Central Asian states and other partners within the S.C.O., to strengthen its global position. If so required, China will not hesitate to use its power against one of its former partners, as is demonstrated by China's efforts to divert energy routes away from Russia.

Russia is well aware that China's growing economic and military importance could develop into a threat. An indication of Russia's concern toward China could be in Moscow's alleged creation of a second joint military grouping of defense forces and internal and security troops. In contrast with the areas of Chechnya and Dagestan, in Russia's Far East there is no threat of Islamic extremism and the formation of a joint military command could only be related to a potential threat from China. In due course, the so far hidden fear of China could cause Russia to draw back from China and to seek an intensification of political and economic ties with the West, even if this abandonment from China would mean that Russia has to accept Western influence in its backyard of the former Soviet Union.

The West will probably have to cope with increasing ties between Russia and China and subsequent policies contrary to Western activities in the Far East and the Pacific. To a certain extent, the West itself is the reason for this rapprochement between Russia and China. All current Russian major security documents clearly demonstrate disappointment in the West for leaving Russia out of Western security policy. The climax of this mistrust has been N.A.T.O.'s war in Kosovo. Although Russian-Western relations since then have improved, the feelings of mistrust and disregard are still evident in parts of Russia's security elite and thus have resulted in closer ties with China.

China's emerging economic and military power will have to be taken into account. China will become a regional and possibly global power with capacities and policies that may counter Western influence not only in the Far East, but elsewhere. Western security policy should be aware of this development. If China indeed achieves such a superpower position, the West and Russia may find common ground to seek closer cooperation.

On July 16, the presidents of Russia and China signed a Treaty for Good Neighborliness, Friendship and Cooperation in Moscow. 1 This treaty is the first such agreement between these two Eurasian powers since Mao Tse-tung signed a treaty with Joseph Stalin of the U.S.S.R. in 1950, four months before the outbreak of the Korean War. That treaty had been driven by anti-Western sentiments. The motivations behind this new treaty are much more complex and involve serious geopolitical, military, and economic considerations. In a sense, this treaty is a logical product of the improvement in Sino-Russian relations that began under the last Soviet leader, Mikhail Gorbachev, and continued under Boris Yeltsin. The treaty should signal to the Western world that a major geopolitical shift may be taking place in the Eurasian balance of power, with serious implications for the United States and its alliances. The treaty comes on the heels of another recent security arrangement involving these two countries: On June 14, Russia, China, and four Central Asian states announced the creation of the Shanghai Cooperation Organization (SCO), an arrangement ostensibly aimed at confronting Islamic radical fundamentalism and promoting economic development. 3 Together, the agreements portend an important evolving geopolitical transformation for Russia and China, two regional giants who are positioning themselves to define the rules under which the United States, the European Union, Iran, and Turkey will be allowed to participate in the strategically important Central Asian region. Many analysts point out that while the United States should monitor these developments, there is still no cause for panic. Contradictions in political objectives continue to exist between China and Russia, including Russia's "primordial distrust" of the Chinese, according to Professor James Sherr of Great Britain's Royal Military Academy at Sandhurst. 4 Nonetheless, there is growing concern that the new treaty between Moscow and Beijing may increase coordination between the two countries against the United States. The Bush Administration should take steps to protect U.S. interests, increase regional security, and counter the threat of proliferation of weapons of mass destruction (WMD). It should, for example, expand intelligence monitoring of the Sino-Russian strategic partnership, including assessing possible secret codicils in the treaty. It should boost military and security cooperation with India and Japan while developing joint efforts with Russia and China to counter radical Islamic threats in Central Asia. And it should offer Moscow incentives to scale down its military cooperation with China, especially with regard to weapons of mass destruction and advanced military technology.

MULTIPOLARITY AND SINO-RUSSIAN STRATEGIC COOPERATION

China and Russia first announced the development of their "strategic partnership" at a Shanghai summit in April 1996. Since then, they have taken steps to boost this relationship. During President Jiang Zemin's visit to Moscow in 1997, he and President Yeltsin committed to promoting a new international policy based on "multipolarity"--the creation of competing centers of power as a response to perceived U.S. dominance. 5 They called for the preservation of the 1972 Anti-Ballistic Missile (ABM) Treaty between the United States and the former Soviet Union, and they supported lifting the U.N. Security Council sanctions against Saddam Hussein's regime in Iraq. 6 The desire to counter U.S. global supremacy and the West's pressure on both countries regarding the rights of independence-seeking ethnic minorities (and human rights in general) furnished much of the impetus for a friendship treaty between Russia and China as well as the creation of the so-called Shanghai-6 Organization (SCO). The parties of this organization vehemently oppose the policy of NATO-led "humanitarian interventions," such as the Kosovo war, which was not sanctioned by the U.N. Security Council. Chairman Jiang has repeatedly declared that "hegemonism and power politics" are the "main source of threat to world peace and stability" as well as China's interests. 7 Beijing is clearly interested in curtailing the U.S.-led condemnations and sanctions of China for human rights, as in the aftermath of the 1989 Tiananmen Square massacre. Furthermore, Russia and China are both seeking to safeguard their status as two of the five permanent members of the U.N. Security Council. Finally, they are working to boost each other's military potential as well as that of other countries that pursue anti-American foreign policies, such as Iran and Iraq. 8 The state-run media in Russia and China often point to "U.S. hegemonism" and "U.S. power politics," and call for the "establishment of a new international order" under United Nations tutelage. 9 Some of the forms of cooperation that have followed such rhetoric clearly pose a threat to U.S. interests. For example, the Russian and Chinese navies began conducting joint military exercises in 1999. 10 These maneuvers included the Russian Pacific Fleet missile cruisers and destroyers as well as warships from the Chinese Eastern Fleet. 11 The Sino-Russian exercises this year allegedly included Russian TU-22 bombers equipped with long-range nuclear-capable cruise missiles flying attack missions against simulated U.S. forces in East Asia. 12 In view of these actions, the assertions made by the Chinese and Russians that the new strategic relationship is not aimed at any one nation have a particularly hollow ring.

13 More than the formalization of the new treaty, it is the massive Russian arms sales and WMD-related technology transfers to China that make the multipolar rhetoric of these new "friends" of particular concern to the United States and its allies in Asia. A world system that is not dominated by one country is attractive to both Moscow and Beijing for similar reasons: Economically, it offers them alternative sources of technology, financing, and markets for their raw materials, goods, and services. Moreover, an overburdened U.S. military would pose less of a risk to Russia and China in the regions where they assert their own power. Alternative poles of power in which there is a proliferation of weapons of mass destruction would force the United States to spread its resources thinly to deal with evolving crises in different regions simultaneously. The reason for Russia's willingness to support China's security interests and vice versa may lie in the fact that each country now views the other as its "strategic rear." 14 Russian leaders have often stated that the threats to Russia are NATO enlargement to the East 15 and radical Islamic forces active in Chechnya and among Moscow's Central Asian allies. Beijing views U.S. predominance in the post-Cold War world--from its success in the Gulf War to its support of Taiwan security--as important threats to China. Russia has stated that "there is only one China" and that Taiwan is China's "internal affair," while Beijing has expressed unequivocal support for Russia's strong-arm tactics in Chechnya. 16 Nevertheless, attempts to add other major Asian powers to this strategic partnership have been problematic. Moscow has tried to woo India into the strategic multipolar relationship by holding out the carrot of access to Russia's military hardware to boost its military capabilities. 17 The problem is that China and India have long been strategic competitors. Russia also has longstanding issues with other Asian countries, such as its dispute with Japan regarding the Northern Territories (Kurile Islands) that the U.S.S.R. occupied in 1945. In addition, Japan is apprehensive about China's bid to dominate East Asia. The task of drawing more countries into this plan may prove very difficult.

ARMS SALES AND MILITARY COOPERATION

China has made it clear that it is interested in creating "pockets of excellence"--local weapons development programs based on foreign technologies; but to do so it must first obtain that foreign technology. The large number of Russian weapons scientists who moved to China over the past decade may be the most dangerous aspect of the Sino-Russian strategic relationship. 18 China was the leading customer of the Russian military-industrial complex in the 1990s. Chinese leaders turned to Russia for weapons systems that were designed to counter the U.S. military in the Cold War. In particular, they have focused on boosting China's missile forces and related space systems as well as air and naval force capabilities. Between 1991 and 1996, Russia sold China weapons worth an estimated $1 billion per year. Between 1996 and 2001, the rate of sales doubled to $2 billion per year. Reportedly, the two had signed a military sales package in 1999 that between 2000 and 2004 would be worth $20 billion. 19 China also obtained important know-how through the theft of U.S. warhead designs and guidance systems technology. 20 In 1999, China tested the JL-2 submarine-launched ballistic missile (SLBM) and the DF-31 intercontinental ballistic missile (ICBM); it also announced its acquisition of the neutron bomb. It has been suggested that Russian scientists and blueprints were used in developing these and other armaments. 21 China is building a modern air force to operate over the East China and South China Seas. In 1993-1997, it acquired 74 SU-27 Flankers and the rights to produce 200 more under a Russian license. 22 These planes are similar to the American F-14s and F-15s. Earlier this year, China acquired 40 SU-30 MKK multi-purpose fourth generation fighter-bombers (a modernized version of the SU-27) as well as the in-flight refueling capability needed to extend the Flanker's range. The Chinese military also purchased a license to produce 250 SU-30 fighters domestically. Altogether, China has bought or is planning to manufacture up to 525 of these combat aircraft. Its air force already has acquired the over-the-horizon targeting capability that may prove crucial in future conflicts, and it is seeking airborne early warning capabilities for wide-area air and naval battle management, most probably by purchasing the Russian A-50 Beriev. 23 China has clearly achieved breakthroughs in missile technology by importing systems and prototypes from Russia. It is deploying S-300 surface-to-air missiles (SAMs) to protect ballistic missile bases that could target Taiwan. It is also developing indigenous SAMs based on Russian designs, such as the S-300, SA-12, and SA-17 Grizzly. 24 Beijing is emphasizing the modernization of the People's Liberation Navy as well. It has acquired four Kilo-class diesel submarines.

Most important, Russia has sold Beijing two Type 956E Sovremenny-class destroyers armed with supersonic, nuclear-capable, Moskit missiles (SS-N-22). This destroyer-missile system was designed specifically to hit U.S. aircraft carriers. Some destroyers to be produced in China are based on Russian know-how. Russia also has sold China its Kamov Ka-28 (Helix) anti-submarine, destroyer-based helicopters. 25 Such transfer of knowledge is the key to China's being successful in upgrading its military potential; Russia and China have established mechanisms for military technology transfer and intelligence sharing. Russia even allowed China to use its space-based global positioning system, known as GLONASS. A real-time satellite imagery download system may also be in operation. Most worrisome, however, is a broad program already in place to train military students, scientists, and engineers. According to Chinese military sources quoted by the Hong Kong media, up to 1,500 Russian scientists work in China's design and production facilities. 26 China is clearly on track to a comprehensive upgrading of its defense research, development, and production programs. 27 The relationship between China and Russia is symbiotic. China is acquiring capabilities to counter U.S. naval and air power in the Far East and intimidate neighbors like Taiwan. Russia is seeking to become a regional rival to the United States, maintaining its defense industrial base and using money from arms sales to China and others to modernize its own armed forces. However, cooperation between the two countries is not limited to military technology and production.

COOPERATION IN CENTRAL ASIA

Opposition to the United States as the sole superpower is not the only consideration driving the developing strategic partnership between Moscow and Beijing. Both Russia and China are concerned about Muslim radical movements in their territories and around their borders. Since the 1970s, the Turkic Muslim Uighurs in the Western Chinese province of Xinjiang, 7 million strong, have been conducting a violent struggle for independence. They have killed police and soldiers, planted bombs, and robbed banks. In 1997, they exploded a bomb in Beijing, wounding 30 people. They have also developed connections to radical Islamic movements and are training in religious schools (medrese) and camps in Afghanistan and Pakistan. Stability in Xinjiang is important to China. It is seen as a test case of central control, relevant to Beijing's grip over Tibet and Inner Mongolia. Xinjiang is also viewed as a traditional buffer against Turkic Muslim invasions from the Northwest. And it contains three major oil basins: the Turpan, Jungar and Tarim, with up to 150 billion barrels of reserves, according to some optimistic estimates. The People's Liberation Army maintains numerous bases and nuclear weapons testing grounds in the region, which could be threatened if the Uighurs gain control. Russia is in a similar position as it enters the seventh year of conflict in Chechnya.

Radical Muslim penetration of other North Caucasus autonomous republics, such as Daghestan, is increasing, as evidenced by non-Chechen participation in terrorist activities in Russia. The Russian leaders fear a chain reaction among the country's 20 million Muslims. In the long term, the threat of Muslim insurrection in Central Asia looms ever larger. The ruling regimes, allied with Russia, suffer from a lack of both legitimacy and democracy. With economic reforms in the Central Asian countries sputtering or stalling, corruption runs rampant, GDPs are flat, and living standards are abysmally low; Islamic radicals are busily recruiting and training the next generation of jihad warriors. The radical drug-pushing Taliban regime across the Amu Darya river is menacing. A flood of drugs and weapons overwhelms the Russian expeditionary force (the 201st Infantry Division) on the Tajik-Afghan border, while indigenous support, corruption, and political maneuvering by Moscow and Dushanbe prevent Russia and the Tajiks from wiping out the Islamic rebels. The secular, authoritarian, and corrupt regimes in Central Asia rely upon their traditional ties to Moscow as life insurance. And Russia believes it must either fight the Islamists in the deserts of Central Asia or face them in Northern Kazakhstan, where many ethnic Russians reside. Russia finds its options limited: to face the instability in Central Asia on its own or to bring in China as a partner. Beijing views Central Asia, with its weak governments and rich natural resources--especially oil and gas--as its future natural sphere of influence. The recent institutionalization of the SCO demonstrates that Moscow and Beijing hope to be the decisionmakers in Central Asia, possibly to the exclusion of Turkey, Iran, and the United States. What remains to be seen is how effective the two counties will be against the Taliban, the Islamic Front of Uzbekistan, and the organization of Osama bin Laden.

ECONOMIC DEVELOPMENT

Economic cooperation is another important leg of the Sino-Russian partnership. If China seeks to maintain its impressive economic growth rate of 1985-2000, it will face a major raw materials shortage--China imported 30 million tons of oil in 1999; by 2010, it may import 100 million tons a year. By 2010, China will face a water deficit of 10 percent of its total consumption. By 2020, it will not be able to supply itself with oil, iron, steel, aluminum, sulfur, and other minerals. Sino-Russian trade was at $5.5 billion in 1999, accounting for 1.6 percent of China's foreign trade and 5.7 percent of Russia's. 28 While the trade structure between these two countries is weak and primarily involves Russian raw materials and Chinese low-quality consumer goods and food, the potential for growth in trade and investment is very high. Chinese experts predict that Russia will be able to export 25 billion to 30 billion cubic meters of natural gas to China annually, as well as 15 billion to 18 billion kilowatts of electricity from the newly completed hydropower stations in Siberia and 25 million to 30 million tons of oil from the Kovykta oil field in Eastern Siberia. In addition, Russia can pump oil produced in Kazakhstan to Irkutsk and then supply it to China. Furthermore, Russia is willing to build six nuclear reactors in China to generate up to 1.5 trillion kilowatts. 29 Russia and China are also seeking high-tech civilian cooperation.

Chinese officials have invited Russian high-tech experts and engineers to build high-tech incubators in the northern city of Harbin. The two countries are considering building a bridge over the Amur river to connect Heihe city in Heilongjiang province with Blagoveshchensk. There also are numerous projects for developing free economic zones along the Chinese-Russian border and an international port in the mouth of the Tumannaya river (Tumangan), where the Russian, Chinese, and Korean borders meet. That port has been on the drawing boards for 15 years. Russia and China also could cooperate in developing a network of railroads and pipelines in Central Asia, building a pan-Asian transportation corridor (the Silk Road) from the Far East to Europe and the Middle East. However, ambitious Chinese plans to build the longest pipeline in the world, from Western Kazakhstan to China, at a cost of $10 billion have run into financing difficulties. 30 Thus far, the target of $20 billion in trade established by Presidents Jiang and Yeltsin in 1997 has not been reached. The West remains China's leading trade partner--a fact that has become a major impediment to a deeper Sino-Russian alliance.

LIMITS TO SINO-RUSSIAN COOPERATION

The West will remain China's leading trade partner for the foreseeable future. Japan, the United States, Taiwan, and Europe account for over $284 billion in trade with China, while Russia and Central Asia provide only $7.7 billion in trade. 31 Moreover, Russia is incapable of meeting China's needs for high technology and foreign investment to maintain its current GDP growth, an important issue if the Communist Party is to maintain its grip on power. From the Russian point of view, the vast and expanding conventional imbalance of military and economic power is a concern.

Many elites and ordinary people in Russia are suspicious of China. Some fear that the underpopulated Russian Far East and Siberia could become targets for Chinese expansionism in the 21st century 32 since the population disparity is immense. Only 8 million Russians live between Lake Baikal and the Pacific, while over 200 million Chinese live in Northeast China. Only 30 million Russians live to the east of the Ural Mountains. The ethnic Russian population of the Far East is falling due to high rates of mortality and emigration back to European Russia, while hundreds of thousands of Chinese peasants, migrant workers, and small traders have moved into the area illegally. Frequent intermarriages are further irritants to the Russian elite. 33 Russia must undergo a steep learning curve to adjust to the growing power of China and forgo the leadership position it historically has occupied in Eurasia. A Russian military force in the Far East will not be capable of countering a powerful Chinese military without increasing reliance on a nuclear deterrent. 34 However, China, with its deeper pockets and larger military, might have to address Central Asian security challenges regardless of Russia's wishes, and China's appetite for Russian raw materials may cause its leaders to ponder the value of their ties with Moscow for their country's economic development. As one expert pointed out, "Russia is likely to discover that it can no longer manage an equal partnership with China"; Russia will "likely face a choice between the increasingly close embrace of a more dynamic China and attempting to find regional and global partners to help balance Chinese influence." 35 Riding the Chinese dragon may prove less comfortable for the Russians than they thought it would be, at which point a renewed interest in a genuine partnership with the United States may emerge. Carefully developing a policy toward the emerging alliance will require monitoring Sino-Russian "friendly" developments.

IMPLICATIONS FOR U.S. FOREIGN POLICY

Though a full confrontation between the United States and Russia and China today is unlikely, a Moscow-Beijing policy of strategic cooperation to limit U.S. policy initiatives may well affect relations between the United States and each of those two regional powers. The situation has evolved beyond Russia's playing the China card to get more Western economic assistance or China's playing the Russia card in order to be taken more seriously in Washington. It is an evolving relationship that requires U.S. policymakers to examine the changing geostrategic reality and take steps to ensure that U.S. security and national interests are not at risk. Russia's military assistance to China, including in the areas of advanced conventional weapons and weapons of mass destruction, should continue to be a major concern of the Bush Administration. Moreover, attempts by both countries to exclude the United States from developing Central Asian energy resources, as well as their support of authoritarian regimes in the interest of "fighting Islamic fundamentalism," must be countered peacefully but firmly. Specifically, the Bush Administration should: More closely monitor relations between Russia and China, especially in national security areas. The intelligence community should be instructed to establish whether secret codicils exist in the new treaty that provide for the parties to conduct joint military action in case of foreign military operations against one of them. Specifically, this intelligence gathering should focus on the possibility of the Russian Pacific Fleet's intercepting the U.S. Seventh Fleet in any confrontation in the East China Sea. It should also examine military and dual-use technology transfer programs between Russia and China, including the involvement of Russian scientific and engineering personnel in modernization programs of the People's Liberation Army. Strengthen military and security cooperation with India and Japan. India has thus far resisted Russia's advances to coordinate security strategy, despite its 50-year-old ties to the Russian military-industrial complex. The Bush Administration should strengthen U.S. cooperation with India to fight terrorism and narcotics trafficking, and it should seek greater cooperation with India on security issues in Central Asia and on assuring freedom of navigation in the Indian Ocean. While the Administration should explore arms sales to India and military-industrial cooperation, it should not allow the United States to become embroiled in helping India settle the Kashmir dispute with Pakistan. Washington and Tokyo should enhance efforts to encourage joint military exercises and the gathering of intelligence about military activities in Russia and China. The United States and Japan should encourage their businesses to invest in the Russian Far East and Chinese Northern provinces and enhance economic ties to these provinces. Offer to help Russia and China counter the efforts of radical Islamic groups in Central Asia, including the Taliban and the Osama bin Laden organization.

Radical Islamic subversion in Central Asia and Xinjiang is a threat to regional security. While opposing Islamic terrorism and militancy, the Bush Administration should help develop the democratic and participatory aspect of civil societies in the region by providing support to developing indigenous democratic institutions, with moderate Islamic participation. It should support the development of joint energy, services, and manufacturing projects in Central Asia among, for example, Russian, Chinese, Turkish, and Indian firms. Beyond such efforts, it should ask to join the SCO as an observer, to examine how sincere China and Russia are about cooperation in dealing with Islamic fundamentalism. Offer incentives to Moscow to prevent the transfer of WMD and advanced military technology to China, Iraq, and Iran. A cooperative relationship between U.S. and Russian aerospace companies and agencies may occur if Russia agrees to prevent the transfer of WMD and sensitive advanced conventional weapons technology to China, Iraq, and Iran. The Administration should explore how to assist Russian companies currently doing business with China in this sensitive area to convert their operations to civilian production. Focus U.S. public diplomacy efforts on the problems inherent in closer Sino-Russian relations. Russians have had many apprehensions regarding China, especially its intentions in the Russian Far East and Siberia. The debate on Sino-Russian relations should be encouraged, involving the U.S. academic community, international broadcasting, and NGOs. Washington should reach out to the Russian people as well as the Chinese business community (through the Chinese-American Chamber of Commerce and other organizations) to explain that a military anti-American alliance between Moscow and Beijing may threaten economic cooperation with the United States, including access to U.S. financial markets.

CONCLUSION

The signing of the Russia-China Treaty of Friendship this week, on the heels of the creation of the Shanghai Cooperation Organization last month, portends the establishment of a strategic partnership that could influence the future of Eurasia and East Asia for decades to come. The anti-American rhetoric that has dominated Russian-Chinese summits in the past, and Russia's military technology transfers to China, are causes of concern for U.S. defense planners. China and Russia have one of the longest land borders in the Eastern Hemisphere, vast human and natural resources, and complementary national economies with great potential for trade and investment. They also have legitimate concerns regarding the spread of terrorism and militant Islam. They have a right to manage their own relations unless it threatens the security interests of third parties, such as India, Japan, and the United States. Washington should support economic cooperation. However, the degree to which the Sino-Russian alliance may become anti-American and anti-Western in the future depends on how deeply the two Eurasian powers feel that the United States threatens their interests. While it values friendly relations with both countries, Washington should oppose anti-American elements in the character and direction of the alliance. Dr. Ariel Cohen, is Research Fellow for Russian and Eurasian Studies in the Kathryn and Shelby Cullom Davis Institute for International Studies at The Heritage Foundation.

Endnotes 1. Vsevolod Ovchinnikov, "No Need to Fear the Chinese Tiger: Russia Enters the 21st Century Shoulder to Shoulder with Its Great Neighbor," Rossiyskaya Gazeta , September 19, 2000, reported as "Russia and China to Sign Friendship and Cooperation Treaty," FBIS-CHI-2000-0919. 2. "Hegemonism" has become a shorthand reference to the global preeminence and superpower status of the United States and includes its plans to deploy missile defense, defend Taiwan, and expand NATO. 3. Martin Fackler, "China and Russia Form New Bloc," Associated Press, June 15, 6:50 a.m. The Shanghai Cooperation Organization (formerly the "Shanghai Five" and now also known as the "Shanghai Six") consists of Russia, China, Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan. 4. James Sherr, "Policy Toward the `Far Abroad,'" Russia in the International System , Conference Report CR2001-02, National Intelligence Council, Washington, D.C., June 2001, p. 22. 5. Helmut Sonnenfeldt, "The Evolving International System and Russia's Relevance," Russia in the International System m> , p. 62. Sonnenfeldt notes that besides China and Russian, the country most ardently denouncing unipolarity is France. 6. "Russian-Chinese Statement," ITAR-TASS, Moscow, December 10, 1999, as reported by FBIS-SOV-1999-1210. 7. Ibid ., p. 28. 8. Ibid ., p. 29. 9. Peng Shujie and Quian Tong, "President Jiang Zemin and President Putin Hold Talks," Xinhua Domestic Service in Chinese, reported as "Jiang Zemin, Putin Hold Talks, Sign Documents," FBIS-CHI-2000-0718. 10. Agence France-Press, "Spokeswoman Says PRC Backs Russia Action in Chechnya," Beijing, October 12, 1999, as reported by World News Connection, FBIS-CHI-1999-1012. 11. Brian Mosely, "Russia a nd C hina to Hold Joint Naval Exercises," Associated Press, September 27, 1999, at http://www.freerepublic.com/forum/a37efa8452c60.htm. 12. Bill Gertz, "Russian Forces Help China in Mock Conflict Nuclear War on U.S. Troops," The Washington Times , April 20, 2001, p. A1. 13. Mark Burles, "Chinese Policy Toward Russia and the Central Asian Republics," RAND Corporation, No. MR-1045-AF, 1999, p. 35, at http://www.rand.org/publications/MR/MR1045. 14. Ovchinnikov, "No Need to Fear the Chinese Tiger." 15. Mikhail Alexeev, "Russia's Foreign and Security Goals," Russia in the International System, pp. 25-26. 16. Robert J. Saiget, "China, Russia Beef Up Cooperation on Ethnic Separatism, Taiwan, Terrorism," Agence France-Press, Hong Kong, November 18, 2000, as reported by World News Connection, FBIS-CHI-2000-1118. 17. Moscow announced that India will finance development of the fifth generation Russian fighter, the Sukhoi SU-37. 18. John Deutsch, Threats to National Security, hearing before the Committee on National Security, U.S. House of Representatives, February 12, 1998, 105th Cong., 2nd Sess., at http://proxy.lib.umich.edu:2059/congcomp/printdoc . 19. Stephen J. Blank, "Military Capabilities of the People's Republic of China," testimony before the Committee on Armed Services, U.S. House of Representatives, 106th Cong., 2nd Sess., July 19, 2000, p. 5, at http://www.fas.org/spp/starwars/congress/2000_h/00-07-19blank.htm. 20. Report of the Select Committee on U.S. National Security and Military/Commercial Concerns With the People's Republic of China (Cox Committee Report), U.S. House of Representatives, Washington, D.C., 1999, pp. 186-187, 191, 196-197. 21. Mark Stokes, "China's Strategic Modernization: Implications for the United States," U.S. Army War College Report, 1999, p. 204, at http://www.nyu.edu/globalbeat/asia/Stokes0999.html ; see also Blank, "Military Capabilities of the People's Republic of China." 22. Burles, "Chinese Policy Toward Russia," pp. 35-36. 23. Jeremy Page, "Russia Seeking to Sell Radar System to China," The Russian Journal , No. 43 (November 4, 2000). 24. See Military Analysis Network, HQ-9/FT-200, at http://www.fas.org/man/dod-101/sys/missile/row/sa-17.htm. 25. Olga Kryazheva, "Russia-China Arms Trade Growing," Weekly Defense Monitor , Center for Defense Information, Vol. 4, Issue 5 (February 3, 2000), at http://www.cdi.org/weekly/2000/issue05.html#5. 26. Tung Yi, "Russian Experts Said Helping PRC Make High Tech Weaponry," Sing Tao Jih Pao , September 6, 2000, p. A39, as reported in FBIS-CHI-2000-0906. Areas of cooperation extend to submarine construction, including advanced models (the 93 and 94); the Jian J-10 fighter jet; nuclear weapons development; cruise missiles; and jet propulsion. 27. Burles, "Chinese Policy Toward Russia," pp. 35-36. 28. Jua Ta-chen, "Thoughts on Issues of Sino Russian Economic and Trade Cooperation Facing the 21st Century," Ta Kung Pao , July 18, 2000, in FBIS-CHJI-2000-0718. 29. Ibid . 30. Burles, "Chinese Policy Toward Russia," p. 36. 31. Calculated from Chinese Foreign Trade Ministry statistics, at http://www.moftec.gov.cn/moftec/official/html/statistics_data/e2000-01-051c.htm , and U.S. Department of Commerce statistics, at http://www.export.gov/docTSFrameset.html , as well as Burles, "Chinese Policy Toward Russia," pp. 20-21. 32. Yu. M. Galenovitch, Rubezh Pered Startom. Kitayskaya problema dlia Rossii I ShA na Poroge XXI Veka , Moscow, Science Public Foundation, 1999, pp. 72-73. 33. Moscow-based experts who requested anonymity, in interviews with the author, Moscow, May 16-20, 2001. 34. Russian military sources have disclosed that there is not a single battle-ready division in the Asian part of Russia. 35. Sherman Garnett, "Slow Dance: The Evolution of Sino Russian Relations," Harvard International Review , Winter 1996-1997, p. 29, as quoted in Burles, "Chinese Policy Toward Russia," p. 48.

Gazprom WANTS oil will reach $250

Gazprom, Russia’s gas monopoly, on Tuesday predicted oil prices would reach $250 a barrel in 2009. The striking prediction came as the International Energy Agency, the developed world’s energy watchdog, warned that record high prices were needed to choke off demand in order to balance the oil market.It is the IEA’s most candid admission to date that oil supply is struggling to catch up with Asian demand, and follows the sharp rise in prices last week, which saw crude jump more than $16.24 in less than 36 hours to a record $139.12. Gazprom’s prediction came at a strategy presentation in Deauville, where Alexei Miller, chief executive, said: “Today we are witnessing a very great change for hydrocarbons. The level is very high and we think it [the price of oil] will reach $250 a barrel.” A company spokesman specified that Gazprom believed that level would be hit in 2009.That is substantially higher than forecasts by analysts, who see oil prices in 2009 ranging between $100 and $200.In its monthly oil market report, the IEA said “supply growth so far this year has been poor and higher prices are needed to choke off demand to balance the market”. It added: “Abnormally high prices are largely explained by fundamentals”. Mr Miller agreed with the IEA’s assessment, saying that speculators were not ”a determining influence”. He said: ”Competition for resources and their use is growing.” The market responded by pushing prices back up after they had fallen below $134 earlier in the session. Nymex July West Texas Intermediate rose 70 cents to $134.95, while ICE July Brent added 53 cents to $134.38.As expected, the IEA cut slightly its forecast for annual oil demand growth, but surprised the market with a deep reduction in its forecast for supply growth from non-Opec nations, leaving the world more dependent on the producers’ cartel. It cut its demand growth forecast further by 80,000 b/d to an annual increase of 800,000 b/d because of record high prices, the slowing US economy and the partial removal of fuel subsidies in some Asian countries.

However, the agency warned that so far, there were “very few signs of slowing demand in non-OECD countries where economic growth is far more significant than price in determining demand”.The cut in the IEA’s forecast for oil demand growth was overshadowed by a larger cut in forecast supplies. The agency cut its forecast for non-Opec supply growth to just 455,000 b/d, or 225,000 b/d below last month’s forecast. It expected most of the non-Opec fresh output to be in the form of biofuels, which would account for 72 per cent of the supply increase. The non-Opec supply growth forecast for 2008 is now below the growth achieved by the group both in 2007 and 2006, in spite of significantly higher oil prices.The agency also warned that the imbalance between demand and supply forced a counter-seasonal drop in rich countries’ oil inventories in April. It estimates that stocks fell in April by 8.1m barrels, compared with a traditional increase in April of about 30m barrels.It warned that current prices could “impinge upon growth prospects”, even though the global economy is more resilient to rising oil prices. “Globally, the high oil price is contributing to inflationary pressures,” it said.The IEA’s warning echoes comments on Monday by Tony Hayward, chief executive of BP, who said the oil market was not well supplied. “In a well functioning market where supply and demand are balanced, prices should be stable. Where prices are high, however, they show that supply is not responding adequately to rising demand ... and that is where we find ourselves today,” Mr Hayward said.Francisco Blanch, head of commodities research at Merrill Lynch, said on Tuesday he was raising his forecast for WTI prices in the second half of the year to $121.50, based “a combination of lower than expected supplies and unrestricted demand. Non-OPEC output is really struggling to expand.”

Russian Prime Minister Vladimir Putin on Monday said it was time for Russia to rebuild links with former Cold War ally Cuba, news agencies reported.The Kremlin is angry at U.S. plans for a missile defence system in Eastern Europe, and last month a news report suggested Russia might use Cuba, a thorn in America's side for half a century, as a refueling stop for nuclear-capable bombers.The Russian Defence Ministry denied the report and said it had no plans to open any military bases abroad, but a top U.S. general was drawn to say such a move would cross a "red line".Moscow was the Caribbean island's key oil, arms and grain supplier for 30 years, until subsidies propping up the economy of Fidel Castro's revolutionary government fell to a trickle and then dried up entirely after the collapse of the Soviet Union."We need to reestablish positions on Cuba and in other countries," news agency Interfax quoted Putin as saying at the weekly presidium meeting of key government ministers.Just 144 km (90 miles) from the coast of U.S. state of Florida, Cuba still has no formal diplomatic ties with Washington D.C.At the height of the Cold War in 1962, a two-week crisis over Soviet missiles on the island nearly led to full-blown war.Putin's remarks came after Russian Deputy Prime Minister Igor Sechin reported on a recent three-day visit to Cuba, where he discussed a raft of trade and investment issues and met with Raul Castro, Fidel's brother and now the island's leader."We agreed on a priority direction for cooperation, this being energy, the mining industry, agriculture, transport, health care and communications," news agency RIA quoted Sechin as saying.


Several Russian ships and 1,000 soldiers will take part in joint naval maneuvers with Venezuela in the Caribbean Sea later this year, exercises likely to increase diplomatic tensions with Washington, a pro-government newspaper reported on Saturday.Quoting Venezuela's naval intelligence director, Salbarore Cammarata, the newspaper Vea said four Russian boats would visit Venezuelan waters from November 10 to 14.Plans for the naval operations come at a time of heightened diplomatic tension and Cold War-style rhetoric between Moscow and the United States over the recent war in Georgia and plans for a U.S. missile defense system in the Czech Republic and Poland.Cammarata said it would be the first time Russia's navy carried out such exercises in Latin America. He said the Venezuelan air force would also take part.Venezuelan President Hugo Chavez, an outspoken critic of Washington, has said in recent weeks that Russian ships and planes are welcome to visit the South American country."If the Russian long-distance planes that fly around the world need to land at some Venezuelan landing strip, they are welcome, we have no problems," he said on his weekly television show last week.Chavez, who buys billions of dollars of weapons from Russia, has criticized this year's reactivation of the U.S. Navy's Fourth Fleet, which will patrol Latin America for the first time in over 50 years.The socialist Chavez says he fears the United States will invade oil-rich Venezuela and he supports Russia's growing geopolitical presence as a counterbalance to U.S. power.Chavez has bought fighter jets and submarines from Russia to retool Venezuela's aging weapons and says he is also interested in a missile defense system. Two Russian strategic bombers landed in Venezuela on Wednesday as part of military maneuvers, President Hugo Chavez said, welcoming the unprecedented deployment at a time of increasing tensions between Moscow and the U.S.The Venezuelan leader said the two Russian Tu-160 bombers will conduct maneuvers and that he hopes to "fly one of those things" himself.Russian military analysts said it was the first time Russian strategic bombers have landed in the Western Hemisphere since the Cold War. The provocative foray into Venezuela was certain to add to the strain in U.S.-Russian relations created over Russia's war in Georgia.Chavez called the deployment part of a move toward a "pluri-polar world" — a reference to moving away from U.S. dominance. "The Yankee hegemony is finished," Chavez said in a televised speech.The Russian Defense Ministry said the bombers flew to Venezuela on a training mission and would conduct training flights over neutral waters in the next few days before returning to Russia, according to a statement carried by Russian news wires.Ministry spokesman Alexander Drobyshevsky refused to say how long the deployment would last or whether the planes were carrying any weapons. Military officers in the past have said Russian strategic bombers do not carry live weapons on patrol flights.NATO fighters escorted the two Russian bombers on their 13-hour trip to Venezuela over the Arctic and Atlantic Oceans, the Defense Ministry said.The Russian deployment appeared to be a tit-for-tat response to the U.S. move to send warships to deliver aid to U.S.-allied Georgia after its war last month with Russia."This is a redux of Cold War games, and a dangerous thing to do," said Moscow-based military analyst Pavel Felgenhauer. "It will only strengthen the hand of those in the United States who want to punish Russia for its action in Georgia.

"Earlier this week, Russia said it will send a naval squadron and long-range patrol planes to Venezuela in November for a joint military exercise in the Caribbean.Alexander Konovalov, head of the Moscow-based Institute for Strategic Assessment, said the deployment would lead to further deterioration in U.S.-Russia relations."It's a demonstration of Russia's ability to do things nasty: You send warships to the Black Sea and we send bombers next to your door," Konovalov said. "It will have a negative impact on global stability.

"Meanwhile, NATO said Wednesday it had ended a routine exercise by four naval ships in the Black Sea. Russia had denounced the exercise as part of a Western military buildup sparked by the Georgia conflict.The alliance said the four ships — U.S. frigate USS Taylor and three similar vessels from Spain, Germany and Poland — were moving back to the Mediterranean Sea after the 18-day mission.Chavez has strongly backed Russia's stance in Georgia. He denied that Russia's plan for a deployment later this year is related, saying the Russian navy's visit has been planned for more than a year.Venezuela remains a leading oil supplier to the United States, but as tensions with Washington have grown, Chavez's government has spent billions of dollars on Russian weapons including helicopters, Kalashnikov rifles and Sukhoi fighter jets.Chavez said Wednesday that Venezuela is looking to buy Russian submarines and is working with Russia to set up an air-defense system including long-range radar and "rockets ready to defend the country."He also announced the country will soon buy 24 Chinese-made K-8 flight training and light attack aircraft. The socialist leader, who survived a failed 2002 coup he blames on Washington, repeated his accusations of U.S.-backed attempts to kill him or topple him, saying U.S. forces are "looking for active soldiers, looking for pilots to bomb Miraflores," the presidential palace. The U.S. Embassy denied it. "The United States continuously strives for positive and productive relations with Venezuela," Embassy spokeswoman Robin Holzhauer said. "Unfortunately, the Venezuelan government often responds to these open overtures with name-calling and storytelling. These Venezuelan actions are unfortunate for both of our countries." Chavez has called the U.S. Navy's newly re-established Fourth Fleet a threat.

On Wednesday, he said he's sure "nuclear submarines pass under our noses" off Venezuela's coast. He said Venezuela is aiming to strengthen its "defensive capability with our strategic allies, and Russia is one of them." Later, Chavez called the U.S. the "empire" as he addressed troops at the christening of a new coast guard patrol ship. "Every day, relations between Venezuela and Russia will continue to deepen." He dismissed comparisons to the Cold War, but mentioned Cuba while saying he had been reviewing flight theory in a simulator in hopes of flying one of the Russian planes. Addressing his close friend Fidel Castro, Chavez said: "I'm going to fly a Tu-160. Fidel, I'm going to fly low past you there."

Russia must stake its claim to a slice of the Arctic's vast resources, the secretary of Russia's Security Council said on Friday at an unprecedented session of the council held on a desolate Arctic island.Russia, the world's second biggest oil exporter, is in a race with Canada, Denmark, Norway and the United States for control of the oil, gas and precious metals that would become more accessible if global warming shrinks the Arctic ice cap.Underlining Russia's claims to the region, Security Council Secretary Nikolai Patrushev assembled the defence and interior ministers and the speakers of both houses of parliament for the meeting on the Arctic island, Russian news agencies reported.Russia, the world's biggest country, says a whole swathe of the Arctic seabed should belong to it because the area is really an extension of the Siberian continental shelf."The Arctic must become Russia's main strategic resource base," Russian news agencies quoted Patrushev as saying. The Council usually meets only in Moscow.Patrushev, formerly Russia's powerful domestic spy chief, said competition from other Arctic powers was increasing and that Russia must strengthen transport links across its Arctic regions to drive development.Canada, Norway, Russia, the United States and Denmark -- which governs Greenland -- all have a shoreline within the Arctic Circle, and have a 200-mile (320-km) economic zone around the north of their coastlines.Russian officials say they are entitled to a bigger share. They base the claim on the contention that the Lomonosov ridge, a vast underwater mountain range that runs underneath the Arctic, is an extension of the Siberian continental shelf.Under the United Nations Law of the Sea treaty, any state with an Arctic coastline that wishes to stake a claim to a greater share of the Arctic must lodge its submission with the U.N.'s Commission on the Limits of the Continental Shelf.

Russian geologists estimate the Arctic seabed has at least 9 billion to 10 billion tonnes of fuel equivalent, about the same as Russia's total oil reserves.Last year a submersible with a senior Russian lawmaker on board planted a Russian flag on the Arctic seabed. The crew were greeted as heroes when they returned to Moscow.Russian news agencies said the special Security Council session was held at the Nagurskaya base, Russia's most northerly border outpost. The base is on Alexandra's Land, part of the Russian-controlled Franz Josef archipelago.Russia flexed its muscles in America’s backyard yesterday as it sent one of its largest warships to join military exercises in the Caribbean. The nuclear-powered flagship Peter the Great set off for Venezuela with the submarine destroyer Admiral Chabanenko and two support vessels in the first Russian naval mission in Latin America since the end of the Cold War. “The St Andrew flag, the flag of the Russian Navy, is confidently returning to the world oceans,” Igor Dygalo, a spokesman for the Russian Navy, said. He declined to comment on Russian newspaper reports that nuclear submarines were also part of the expedition. The voyage to join the Venezuelan Navy for manoeuvres came only days after Russian strategic nuclear bombers made their first visit to the country. Hugo Chávez, the President, said then that the arrival of the strike force was a warning to the US. The vehemently antiAmerican Venezuelan leader is due to visit Dmitri Medvedev, the Russian President, in Moscow this week as part of a tour that includes visits to Cuba and China. Peter the Great is armed with 20 nuclear cruise missiles and up to 500 surface-to-air missiles, making it one of the most formidable warships in the world. The Kremlin has courted Venezuela and Cuba as tensions with the West soared over the proposed US missile shield in Eastern Europe and the Russian invasion of Georgia last month. Vladimir Putin, the Prime Minister, said recently that Russia should “restore its position in Cuba” – the nation where deployment of Soviet nuclear missiles in 1962 brought Russia and the United States to the brink of nuclear war. Igor Sechin, the Deputy Prime Minister, made clear that Russia would challenge the US for influence in Latin America after visits to Venezuela, Nicaragua and Cuba last week. He said: “It would be wrong to talk about one nation having exclusive rights to this zone.” Moscow was infuriated when Washington sent US warships into the Black Sea to deliver aid to Georgia after the war. Analysts said that the Kremlin was engaging in gunboat diplomacy over the encroachment of Nato into the former Soviet satellites of Georgia and Ukraine. Pavel Felgengauer, a leading Russian defence expert, told The Times: “It’s to show the flag and the finger to the United States. They are offering a sort of gangland deal – if you get into our territory, then we will get into yours. You leave Georgia and Ukraine to us and we won’t go into the Caribbean, OK?” He described the visit as “first and foremost a propaganda deployment”, pointing out that one of the support vessels was a tug in case either of the warships broke down. Latin America was one of the arenas of the Cold War in which the US and the Soviet Union battled for ideological dominance. Russia has agreed to sell more than $4 billion (£2 billion) worth of armaments to Venezuela since 2005 and disclosed last week that Mr Chávez wanted new antiaircraft systems and more fighter jets. Mr Dygalo denied any link with Georgia and said that Mr Chávez and Mr Medvedev had agreed on the exercises in July. Sea power In the Battle of Tsushima in 1905 – the largest naval battle since Trafalgar – the Russian fleet sailed 18,000 miles (33,000km) to Port Arthur in the Pacific, where it was outmanoeuvred and destroyed by Japanese forces During the 1962 Cuban missile crisis, the Soviet Navy conducted 180 voyages on 86 ships to transfer weapons to Cuba. Russian President Dmitry Medvedev's visits to Venezuela and Cuba during a week-long trip to Latin America look set to irk Washington, highlighting a foreign policy challenge facing President-elect Barack Obama. His trip to Venezuela, a key buyer of Russian arms, coincides with the two countries' first joint naval exercise in the Caribbean -- traditionally viewed by the United States as its backyard. During his stay in Cuba, the Russian leader is likely to demonstrate Moscow's commitment to renew a Cold War-era alliance with Havana, abandoned after the collapse of the Soviet Union. Russia has stepped up ties with Venezuela and Cuba as its relations with the West and particularly the United States soured in the past few years amid a series of rows ranging from Kosovo to U.S. missile defense plans in Eastern Europe. The ties plummeted to a post-Cold War low after the West condemned Russia's invasion of Georgia in August. Moscow, annoyed by NATO warships appearing in or near its borders in the Black Sea to deliver aid to Georgia, dispatched its own warships to the Caribbean for the exercises with Venezuela, a buyer of billions of dollars in Russian arms. Ahead of Medvedev's visit, the Russian military said they were discussing with Havana air defense cooperation. Medvedev marked Obama's election victory on November 4 with the announcement of plans to deploy Russian missiles close to NATO's European borders in retaliation for Washington's plans to set up elements of its missile defense system in Eastern Europe. But later he softened his tone, saying Moscow pinned hopes on the new U.S. administration making steps to improve ties. Medvedev said on November 14 Russia will not be the first to deploy its missiles and called on Obama to revise the shield plans -- seen by Moscow as a security threat.

BROADENING TIES Medvedev's November 26-27 visits to Venezuela and Cuba are the expected highlights of a tour formally centered on his participation in the summit of the APEC Asia-Pacific Economic Cooperation forum in Peru on November 22-24. Kremlin officials say the visit has no political context and is targeted at expanding Russia's presence in Latin America and the broader Asia-Pacific region, viewed by Moscow as one way to help cushion against the effects of the economic crisis. "There is no specific message," one official said. "Latin America is far away and the president naturally used the opportunity of the APEC summit to visit as many countries as possible to promote better bilateral ties." Russia, which wants to diversify its current Europe-focused trade, has sought to establish itself as an Asia-Pacific player, using APEC participation as one vehicle to do so. At last year's summit in Australia, Moscow won the right to hold the grouping's summit in 2012. A presence in Asian and Latin American markets is becoming increasingly important for Russia as Europe and the United States enter a recession. Analysts say emerging markets like China and India have better chances to maintain some growth. "We need to expand to new markets or, at least, make sure that we maintain our positions in markets where we are already present," Medvedev told government officials earlier this week. Russia has been actively negotiating access to Venezuela's oil sector and is eyeing Brazil's lucrative metals and agricultural sectors. Medvedev is likely to throw his weight behind Russian companies in the two countries. His visit to Brazil is also expected to give a boost to ties amongst the BRIC group that also includes India, China and Russia. Foreign ministers from the fast-growing BRIC nations, which are pressing for equal participation in drafting a new global financial architecture, met in Moscow in May. Medvedev is due to visit Brazil on November 24 and will stop briefly in Portugal on his way to Latin America on November 21. spy at the heart of Nato may have passed secrets on the US missile shield and cyber-defence to Russian Intelligence, it has emerged. Herman Simm, 61, an Estonian defence ministry official who was arrested in September, was responsible for handling all of his country's classified information at Nato, giving him access to every top-secret graded document from other alliance countries. He was recruited by the Russians in the late 1980s and has been charged in Estonia with supplying information to a foreign power. Several investigation teams from both the EU and Nato, under the supervision of a US officer, have flown to the Estonian capital Tallinn to assess the scope of what is being seen as the most serious case of espionage against Nato since the end of the Cold War. “The longer they work on the case, the more obvious it becomes how big the impact of the suspected treachery really is,” according to Der Spiegel magazine. A German official described the Russian penetration of Nato as a "catastrophe". Comparisons are being drawn with the case of Aldrich Ames, the former head of the CIA counter-intelligence department who was in effect Russia's top agent in the US. "Simm became a proper agent for the Russian government in the mid-1990s," says the Estonian deputy Jaanus Rahumaegi who heads the country's parliamentary control commission for the security services. On the face of it, the Simm case resembles the old-fashioned Cold War spy story. He used a converted radio transmitter to set up meetings with his contact, apparently someone posing as a Spanish businessman. As in the 1950s and 1960s, it seems that the operation was a husband-and-wife team. His wife Heete – who previously worked as a lawyer at the national police headquarters – has also been detained on charges of being an accessory to treason. Mr Simm was ensnared because of blunders that have dogged modern espionage ever since the KGB first pitted itself against the West. First, he bought up several pieces of valuable land and houses including a farmhouse on the Baltic Sea and a grand white-painted villa outside Tallinn. Second, his contact officer got careless and tried to recruit a second agent – who reported the incident to the security authorities. That is when the Estonian mole-hunters began to reconstruct the movements of the supposed Spaniard and followed the thread back to the agent inside Nato. But Mr Simm was not some relic from the days of Kim Philby or other notorious deep-cover agents. He was at the cutting edge of one of Nato’s most important new strategic missions: to defend the alliance against cyber-attack. Mr Simm headed government delegations in bilateral talks on protecting secret data flow. And he was an important player in devising EU and Nato information protection systems.

Estonia – described by NATO Secretary General Jaap de Hoop Scheffer as "Nato's most IT-savvy nation" – conducts much of its government and commercial business online. People vote and pay their taxes online, government meetings involve almost no paperwork. As a result, when it angered Russia in 2007, by removing a Soviet war memorial, it became the target of hostile attacks on the internet. Estonia has been lobbying hard to put cyber-defence on the Nato agenda, and has set up a Cyber Defence centre in Tallinn which is supposed to help the Alliance as a whole. Now that project could be compromised. The other important question in the Simm case is whether he was operating alone. A senior Estonian police officer claimed asylum in Britain in the 1990s reportedly telling the authorities that he was trying to escape pressure from the Russian secret service to sell secrets. The Russians, it seems, were keen to buy as many place-men as they could: the prospect of Nato forces hard up against the northern Russian border was too alarming for the Kremlin. Moreover, Mr Simm was for many years in charge of issuing security clearance: he could have nodded through other Russian agents. Mr Simm is likely to be formally arraigned at the beginning of next year after the damage control teams from Nato have completed their work. If found guilty he could face between three and fifteen years in prison. Neither the Simms, nor their defence lawyer, have commented on the charges. Nato too has refused to say anything. But there is no doubting that the case is a serious embarrassment. And though Russia may have lost an agent – "a gold card operative" according to one Estonian newspaper – it has achieved a tactical victory by sewing suspicion between western Nato members and the new east and central European entrants.

Russian President Dmitry Medvedev on Friday embarked on a four-nation Latin American tour seen as sending a defiant message to the United States at the close of the George W. Bush presidency. The tour, including talks with the outgoing US leader, naval exercises off Venezuela and a visit to arch US foe Cuba, has evoked fears of renewed Cold War-style rivalry in Latin America, while attracting some ridicule from sceptics. "The current level of cooperation could be broader than in the Soviet era. Latin America has already ceased to be the United States' backyard," a Russian diplomatic source told the Russian daily Kommersant. "Now the region is following its own line, which gives Russia an opportunity to strengthen our position," said the official. Medvedev starts his tour in Peru, meeting Bush at the Asia-Pacific Economic Cooperation (APEC) forum, where Russia's anti-US stance and failure to join the World Trade Organization contrasts with the views of most members. Officials said Medvedev and the outgoing US leader would discuss the global financial crisis, the August war in Georgia and the touchstone issue of US missile defense plans in eastern Europe. Russia analysts say Moscow's quest for influence in Latin America is intended to counter US influence in the former Soviet satellites of eastern Europe, the Caucasus and Central Asia. On Monday the Russian leader heads to Brazil, a key trading partner with which Russia is interested in joint energy projects. On Wednesday, he goes to Venezuela for talks with President Hugo Chavez, a vocal critic of Washington, as Russian warships led by a nuclear-powered cruiser prepare for joint exercises in the Caribbean Sea. Russian media say officials will also pursue arms and energy deals with Venezuela, which has already bought a slew of Russian weapons.

The weapons sales have prompted concern on the part of US ally Colombia that Venezuelan stockpiles could fall into the hands of leftist FARC rebels. Lima-based analyst Alejandro Deustua, of the country's Diplomatic Academy, criticised Russia's military role in South America, saying it was time for Russia to "explain plainly to each South American country what their intentions are with these military exercises." Russian Foreign Minister Sergei Lavrov insisted Russian weapons sold in Latin America were defensive rather than offensive and that Russian moves were not aimed at "third countries" -- a clear reference to the United States, RIA Novosti reported. Medvedev rounds off his tour in Cuba, the flagship ally of the Soviet Union in the Cold War and the United States' communist arch-foe in the western hemisphere since the late 1950s. Russian energy firms have been actively seeking projects in Latin America such as possible involvement in a planned South American gas pipeline. A proposed Russian purchase of a major stake in Spanish energy company Repsol -- a major player in the region -- is likely to advance such goals. But Medvedev's tour has drawn repeated sniping from the influential daily Kommersant, which said Russia's plans were falling apart as oil prices fell and Moscow's economic fortunes plunged. The newspaper wryly noted Chinese President Hu Jintao had beaten Medvedev to the region on a tour this week and observed: "The Russian delegation headed by Medvedev may not be offered the most profitable contracts in Cuba but only those that don't appetize Chinese businessmen." Latin America analyst Johanna Forman, of the Center for Strategic and International Studies in Washington, described as "ham-fisted" a trip crafted months before the November 4 election victory of a more conciliatory US president, Barack Obama. "It's more an in-your-face approach that may not resonate when you have a new administration ... The Russians are still fighting a war with Bush," she said.

Russian President Dmitry Medvedev agreed to help start a nuclear energy program in Venezuela and said Moscow is willing to participate in a socialist trade bloc in Latin America led by President Hugo Chavez. Medvedev used his visit to Venezuela—the first by a Russian president—to extend Moscow's reach into Latin America and deepen trade and military ties. Chavez denied trying to provoke the United States, but he welcomed Russia's growing presence in Latin America as a reflection of declining U.S. influence. Chavez and Medvedev planned to visit a Russian destroyer docked in a Venezuelan port on Thursday. The arrival of Russian warships this week for training exercises with Venezuela's navy was the first deployment of its kind in the Caribbean since the Cold War. Accords signed Wednesday included one pledging cooperation in nuclear energy for peaceful uses. Russia also agreed to work with Venezuela in oil projects and building ships. Moscow plans to develop a nuclear cooperation program with Venezuela by the end of next year, said Sergey Kirienko, head of the Russian Federal Atomic Energy Agency. "We are ready to teach students in nuclear physics and nuclear engineering," he said through an interpreter. He said the help would include "research and development" and "looking for uranium in the territory of Venezuela." Chavez says Venezuela hopes to build a nuclear reactor for energy purposes. The Venezuelan leader—one of the world's most strident U.S. critics—thanked Medvedev for helping to create a "multi-polar" world with declining U.S. influence. Medvedev called Venezuela "one of our most important partners in Latin America" and pledged to keep supplying the South American nation with weapons. But he said arms sales to Venezuela "are not aimed against any other country."

Chavez's government has already bought more than $4 billion in Russian arms, including Sukhoi fighter jets, helicopters and 100,000 Kalashnikov rifles. Chavez had assembled a group of Latin American allies for talks hours before Medvedev's visit, and leaders including Bolivia's Evo Morales and Nicaragua's Daniel Ortega joined them for a late-night meeting. Medvedev said Russia is ready to "think about participating" in the Bolivarian Alernative for the Americas, likely as an associate member. Chavez launched the socialist trade bloc, named after South American independence hero Simon Bolivar, as an alternative to U.S.-backed free-trade pacts. The Russian naval squadron deployed to the Caribbean includes the destroyer Admiral Chabanenko and the nuclear-powered cruiser Peter the Great, the largest in the Russian fleet. The military show of force is widely seen as a demonstration of Kremlin anger over the U.S. decision to send warships to deliver aid to Georgia after its conflict with Russia, and over U.S. plans for a European missile-defense system. But U.S. Secretary of State Condoleezza Rice told reporters in Washington on Wednesday that "a few Russian ships is not going to change the balance of power" in the region. Medvedev was to finish his four-nation Latin American tour in Cuba. Medvedev said he also discussed the global financial crisis with Chavez, and "exchanged different ideas of what actions to take in this situation." Chavez blames the financial crisis on U.S. free-market capitalism.

Russia will complete Iran's first nuclear power plant in 2009, Itar-Tass news agency quoted the head of Russia's state nuclear corporation as saying on Thursday. The launch of the Bushehr plant's nuclear reactor has frequently been delayed. Russian and Iranian officials have given different dates for the start-up. Iran's foreign minister said last year the plant would launch in mid-2008. Russia has already delivered nuclear fuel under a $1 billion contract to build the Bushehr plant on the Gulf coast in southwest Iran. Russia has blamed previous delays on problems with receiving payment from Iran. "Work is ongoing and certain difficulties which arose, including those connected with timely financing, are being resolved due to joint efforts between the Iranian purchaser and the Russian contractor," Tass quoted Sergei Kiriyenko, the head of Russia's Rosatom nuclear corporation, as saying. "Next year we should conclude all the work," Kiriyenko was quoted as saying. Kiriyenko was in Caracas, Venezuela, accompanying President Dmitry Medvedev on a visit. Russia agreed in 1995 to build the plant on the site of an earlier project begun in the 1970s by German firm Siemens. The Siemens project was disrupted by Iran's 1979 Islamic revolution and the 1980-88 Iran-Iraq war. "The position of Russia has not changed: that Bushehr should be finished as soon as possible," a spokesman for Rosatom said. "But that must not affect the security of the plant and the functioning of its systems." "The main question is the integration of Russian equipment with the equipment delivered to the plant at Bushehr by the Germans," the spokesman said. Atomstroyexport, the Russian firm building the plant, said in September the plant was nearing completion and that it would start "technological work" in December 2008 to February 2009 that would put the plant on an "irreversible final" course.

Analysts say Russia has used Bushehr as a lever in relations with Tehran, which is at loggerheads with the West over its nuclear programme. Russia's Foreign Minister Sergei Lavrov has repeatedly said Moscow does not want Iran to be armed with nuclear weapons but that Russia has seen no evidence that Tehran is seeking to build atomic bombs. Iran denies having a bomb programme and says it has the right to develop civilian nuclear power. Russian and U.S. officials point to cooperation over Iran as an area where Moscow and Washington have been able to work together despite a general cooling of ties.

Three Chinese  institutions were among the world's top four banks at the end of 2007 at a time when the market capitalisation of Western banks was suffering from a global financial crisis, a study showed Wednesday. The number one spot in the rankings, compiled by the Boston Consulting Group, was occupied by the Industrial and Commercial Bank of China, with market capitalisation of nearly 340 billion dollars (218 billion euros). In second place was China Construction Bank, followed by HSBC of Britain, Bank of China, Bank of America and Citigroup of the United States. The study found that banks in North America and Western Europe had suffered a loss of 695 billion dollars in market capitalisation at the end of 2007 while their counterparts in emerging market countries Brazil, Russia, China and India had seen their market capitalisation increase by 753 billion dollars. Major US and European banks have suffered losses and asset writedowns stemming from the near collapse of US subprime -- high risk -- mortgage sector, which undermined the value of billions of dollars' worth of their mortgage-backed securities.

This is another reason why the US government shouldn't be spending borrowed money to finance extra-constitutional spending. The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation. Two officials at leading Communist Party bodies have given interviews in recent days warning - for the first time - that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress. Shifts in Chinese policy are often announced through key think tanks and academies. Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is already breaking down through historic support levels. It would also cause a spike in US bond yields, hammering the US housing market and perhaps tipping the economy into recession. It is estimated that China holds over $900bn in a mix of US bonds. When the federal government is asked to do things the Constitution doesn't tell it to do, and when more and more money flows through it, and with that more and more power, it's hard to stop spending. And with that comes borrowing. And with that comes slavery. The same thing could happen even if spending were kept in the context of the Constitution, but once you escape its limits, there is then no limit. The rich rule over the poor, and the borrower is servant to the lender. - Proverbs 22:7 (NIV)

China's oil giant Sinopec Group has signed a US$70 billion oil and natural gas agreement with Iran, which is China's biggest energy deal with the No. 2 OPEC producer. Under a memorandum of understanding signed Thursday, Sinopec Group will buy 250 million tons of liquefied natural gas over 30 years from Iran and develop the giant Yadavaran field. Iran is also committed to export 150,000 barrels per day of crude oil to China for 25 years at market prices after commissioning of the field. Iran's oil Minister Bijan Zanganeh, who is on a two-day visit to Beijing pursuing closer ties, said Iran is China's biggest oil supplier and wants to be its long-term business partner. Official figures show that China imported 226 million tons of oil in2003, about 13 percent of which coming from Iran. Beijing expects to secure foreign energy supplies by the deals for its economy, which has turned China into a major oil importer but suffers severe power shortages.A former KGB officer said to be close to President Vladimir Putin was selected at a shareholders meeting Monday to head Transneft, the state-owned monopoly pipeline operator. Nikolai Tokarev had run state-owned oil exporting firm Zarubezhneft since 2000, the year Putin became president. He previously had served a brief stint at Transneft as vice president. Tokarev will replace Semyon Vainshtok, who was picked to head the state-run corporation overseeing construction of sports facilities and infrastructure in Sochi for the 2012 Winter Games.

The choice of a former KGB officer to run Transneft, which is 75 percent state owned, comes ahead of parliamentary and presidential elections in Russia and fits a Kremlin pattern of putting trusted people in key government and corporate positions. "This is part of the configuration around the presidential succession," said Vladimir Pribylovsky, a political analyst.Bulgaria and Russia signed a deal Friday to build a natural gas pipeline that would undercut a rival project backed by the U.S. and European Union and strengthen the Kremlin's dominance over EU energy supplies.The agreement came after visiting Russian President Vladimir Putin pushed hard to secure Bulgaria's crucial participation in the projected South Stream pipeline, which would cross from Russia under the Black Sea to Bulgaria and then branch off for delivery deeper in Europe. Putin brushed off concerns about Russia's increasing influence, saying after the signing ceremony that the pipeline agreement and other deals would "seriously increase the energy security of the Balkans, Europe as a whole and, of course, Bulgaria." The deal required last-minute negotiations, amid tough bargaining by Bulgaria and wariness about Russia's clout. The Bulgarian Cabinet approved the agreement at an extraordinary meeting only a few hours before it was signed.Bulgaria's interests are fully protected, because the company which will be set up to construct and run the pipeline on Bulgarian soil will be with 50 percent Bulgarian and 50 percent Russian ownership," Bulgarian Prime Minister Sergei Stanishev said. Russia's state-controlled gas monopoly, OAO Gazprom, had previously been offering a minority stake in the part of the pipeline that would run through Bulgaria.

"Until yesterday, the Russian side insisted on holding a 51-percent stake," Stanishev said. He said Putin himself deserved most of the credit for the progress in the late-night negotiations. But despite the concession, the imminent deal was a victory for Putin and Russia, which is already Europe's dominant gas and oil supplier and is seeking to increase its control over westward routes for its energy supplies from the former Soviet Union. "It's very important that the parties have shown their ability to compromise, and the draft that has been was prepared reflects a balance of interests," Gazprom chairman Dmitry Medvedev, who is likely to succeed Putin after the March 2 presidential election, said after meeting with Stanishev. He said agreements on South Stream "will work for decades and make it possible to ensure stable conditions for future energy deliveries for Bulgaria, Russia and EU nations."

Gazprom has set up a parity joint venture with Italy's ENI SpA to develop a feasibility study for the 900-kilometer (550-mile), $10 billion pipeline. The project is a direct rival to the Nabucco pipeline, sponsored by the United States and the European Union, which would also come through Bulgaria. Taking advantage of the clashing pipeline offers, Bulgaria has bargained with the Kremlin. On Thursday, Bulgarian President Georgi Parvanov underlined his nation's support for the EU's efforts to diversify energy supply routes -- and for Nabucco -- in a speech at a ceremony marking the opening of a Russian cultural festival in Bulgaria. After Parvanov had spoken, a clearly annoyed Putin, standing next to him, said Bulgaria was free to chose its direction but warned it to make sure it "works to its benefit." ENI CEO Paolo Scaroni played down the rivalry between South Stream and Nabucco following meetings with Gazprom CEO Alexei Miller, saying both would be needed because of growing demand. But South Stream would undercut Nabucco and dash the European Union's hopes of reducing its growing reliance on Russia, which now supplies up to 40 percent of Europe's gas and up to a third of the oil imports of some European countries. South Stream would have an estimated annual capacity of 30 billion cubic meters (1.15 trillion cubic feet), roughly equivalent to 60 percent of the natural gas consumed annually in The Netherlands. The Kremlin's plans have upset opposition parties and non-governmental organizations in Bulgaria, who fear the former Soviet satellite's increasing dependence on Russian energy supplies and criticize Moscow's human rights record. With Putin and Parvanov looking on, officials also signed a $5.9 billion contract to build Bulgaria's second nuclear plant near the northern town of Belene.

Also signed was an agreement for a joint company, also including Greece, to build the Burgas-Alexandroupolis oil pipeline, which will channel Russian oil from the Black Sea to the Aegean, bypassing Turkey's busy Bosporus. As part of its energy blitz, Russia has promised to extend South Stream into Serbia and build a huge gas storage facility there -- moves that would turn the Balkan nation into a major hub for Russian energy supplies to Europe. Miller said Gazprom and Serbian officials were close to a final agreement on a deal that would envisage a South Stream branch reaching Serbia, and would also foresee Gazprom taking a controlling stake Serbia's state oil company NIS. Belgrade has turned increasingly away from the West and toward Russia, which has supported Serbia in the debate over independence for Serbia's Kosovo province.

With the official launch of the Chinese Investment Corp, China's new financial juggernaut will be both a formidable opportunity and challenge for the west. The Chinese Investment Corp. (CIC) has been officially launched, and with an initial endowment of US$200 billion the new state-controlled company is tasked to invest abroad China's huge foreign reserves. In the shopping bag there will be natural resources from developing countries as well as foreign technologies, research and development (R&D) establishments and brand names from developed economies. For the west, China's new financial juggernaut will be a formidable opportunity, and a formidable challenge. After various announcements, on 27 September, the Chinese authorities officially unveiled the CIC. Under the direct supervision of the State Council, the nation's cabinet, the CIC is mandated to invest abroad the huge reserves accumulated by Beijing over the last years. China's forex topped US$1.33 trillion at the end of June and are expected to reach US$1.5 trillion by the end of the year, the largest in the world. Lou Jiwei, a deputy-secretary general of the State Council and former finance minister, will be the director of the new company.

China's investment corporation has been under preparation for some time. At the conclusion of the annual session of the National People's Congress in March, the Chinese government announced that it would set up a State Foreign Exchange Investment Company (SFEIC) aimed at improving the yield of the country's foreign exchange reserves and generating the largest returns possible. In May, the new company, while still in preparation, invested US$3 billion of its reserves in non-voting shares of the Blackstone Group, the New York-based private equity firm that recently went public. With the establishment of the CIC at the end of September, the contours of China's investment strategy have become clearer. The CIC strategy
The CIC is modeled on the Singapore investment company, Temasek Holdings. Temasek is an investment firm incorporated in 1974 and headquartered in Singapore. Its portfolio spans various industries including telecommunications and media, financial services, real estate, transportation and logistics, energy and resources, infrastructure, engineering and technology as well as bioscience and healthcare. The Chinese sovereign wealth fund will also be a private equity vehicle, operating on a flexible investment horizon with the option of taking concentrated risks. Lou Jiwey, the CIC's director, declared that the new company would "invest, manage and add value to the Chinese portfolio" as an owner of its assets and investments. Beijing currently holds its reserves in US treasury bonds and other safe but low-yielding, instruments. According to Chinese sources, the CIC will likely be "equity-heavy." Analysts at Morgan Stanley also expect the Chinese company to hold a substantial share of its assets in equities, not sovereign bonds. "The company's principal purpose is to make profits," Li Yang, director of the finance research institute at the Chinese Academy of Social Sciences (CASS), told ISN Security Watch. The CIC has an initial capital of US$ 200 billion, but presumably the amount will be increased according to the investments that the company will support. In practice, the CIC will issue RMB-denominated bonds and sell these bonds on the market to buy foreign exchange funds from the central bank. It will then use the foreign exchange funds for investment. In June, China's legislature approved a special issuance of RMB 1.55 trillion (US$200 million) in treasury bonds for the new investment company. The CIC will operate in both the domestic and global markets. Internally, the investment channels of the new vehicle will include another Chinese state-owned company founded in 2003, the Central Huijin Investment Corp., which has been merged into the CIC as a wholly owned subsidiary company. Central Huijin holds shares in China's four leading commercial banks and in 2005 injected US$60 billion into three of them. While Central Huijin will be one of the financial vehicles adopted as the central bank's investment arm to improve the balance sheets of Chinese state-owned banks, the CIC will be more of a strategic investment fund focused on industry and private equity. Internationally, the CIC will be Beijing's investment arm in a range of sectors and countries. Its initial endowment and future prospects make it one of the biggest in the world.

According to a report by Chatham House published in September, the CIC soon will be the number two in the world, behind the Adia, the sovereign wealth fund of the United Arab Emirates, but ahead of both the Gic, the Singaporean fund, and the Norwegian Government Pension Fund. The central question is therefore where and in which sectors the CIC will invest its capital. According to sources, China's international investment strategy will take two directions. One the one hand, it will invest in natural resources in developing countries. On the other hand, it will concentrate on the acquisition of foreign technologies, R&D establishments and brand names in advanced economies. According to Li Rongrong, director of the China State Asset Management Commission (the agency that oversees government assets), the CIC may also help major state-owned companies expand overseas.

Taking the world by investment
Since the mid-1990s, the search for natural resources has continued to gain momentum as a result of China's high economic growth, with increasing emphasis on oil and industrial raw materials. In its 2006 World Investment Report, the United Nations Conference on Trade and Development (UNCTAD) indicated that China's outward foreign direct investment had more than quintupled in the first half of this decade, to reach US$11.3 billion in 2005. South-East Asia, Latin America and Africa have become the prime targets. For instance, in 2002, the China National Offshore Oil Corporation became the largest foreign oil producer in Indonesia after its takeover (for US$585 million) of Repsol Indonesia. In Africa, China's investment strategy has been directed mainly at sourcing natural resources, including oil. Moreover, increasing numbers of Chinese companies have recently established production bases to supply local markets with cheap products highly compatible with local demand and purchasing power. As a result, total trade between China and Africa nearly quadrupled in six years, from US$10.8 billion in 2000 to nearly US$40 billion in 2006. China is today Africa's biggest trading partner and the second most important investor. China's new investment company will further boost these trends. At the same time, China will invest more and more in developed countries, where its presence is often welcomed for the jobs, cash and infrastructure that it brings. In Australia, for example, China has become the biggest foreign investor in the mining sector. The CIC will place more emphasis on the acqui¬sition of advanced technologies, R&D establishments, managerial know-how, distribution networks and brand names. China's investment strategy will likely take the form of profitable participation in private equity funds as well as strategic participation in foreign investment companies running businesses considered of importance for China. While normally in the first case, the CIC would hold a minority stake or give up voting rights for the entitlement of a higher return (as in the Blackstone investment fund), in the event of acquisitions of strategic assets, China's investment company would presumably detain the majority of shares or in any case full control of the company. It is in this scenario that questions of corporate governance, transparency and strategic considerations will be unavoidable.

Eye on Europe: challenge and opportunity
While in the US protectionist tendencies may create difficulties for China investing in key strategic sectors, Europe is emerging as the most attractive place for China's technology-seeking shopping spree. China is eyeing Europe's IT, aerospace and defense sectors as investment opportunities, both in terms of profitable returns on its foreign reserves and in terms of acquisition of advanced technologies needed for China's industrial (and military) modernization. Chinese investments in European companies would be helped by the fact that EU-China relations are characterized by the conspicuous absence of issues that could provoke a confrontation between the two sides - such as the Taiwan question. Unlike the US and Japan, Europeans look at China almost exclusively in terms of business opportunities and not as a possible military competitor. Some EU policy makers - such as the Italian minister for the economy, Tommaso Padoa-Schioppa - have openly invited the CIC to invest in Europe. At the same time, French President Nicolas Sarkozy and German Chancellor Angela Merkel have called for a European "golden share" to protect industrial strategic assets from unwanted takeovers from sovereign wealth funds (SWFs). EU Economy Commissioner Joaquin Almunia added that "the EU might restrict investments by government funds unless they disclose more about what they invest in and why." The CIC will thus be, on the one hand, a great opportunity for some industrial sectors, as it will offer fresh money into tight markets after the sub-prime mortgage crisis. On the other hand, the Chinese investment vehicle could well succeed in gaining control of western assets and advanced technology that could be turned into military might in a situation where there could be future tensions in US-China relations, especially over Taiwan. In sum, for the west, the new Chinese investment corporation will be a great economic opportunity, but also a formidable strategic challenge to watch.

Three Chinese banks in world's top four: study

Three Chinese institutions were among the world's top four banks at the end of 2007 at a time when the market capitalisation of Western banks was suffering from a global financial crisis, a study showed Wednesday. The number one spot in the rankings, compiled by the Boston Consulting Group, was occupied by the Industrial and Commercial Bank of China, with market capitalisation of nearly 340 billion dollars (218 billion euros). In second place was China Construction Bank, followed by HSBC of Britain, Bank of China, Bank of America and Citigroup of the United States. The study found that banks in North America and Western Europe had suffered a loss of 695 billion dollars in market capitalisation at the end of 2007 while their counterparts in emerging market countries Brazil, Russia, China and India had seen their market capitalisation increase by 753 billion dollars. Major US and European banks have suffered losses and asset writedowns stemming from the near collapse of US subprime -- high risk -- mortgage sector, which undermined the value of billions of dollars' worth of their mortgage-backed securities.

An analysis of the world's 25 largest companies by market value provides some telling insights into the tectonic shifts shaping global markets. The United States continues to dominate the ranks of the world's biggest companies, but to a much lesser degree than it did even a decade ago. It now accounts for nine of the Top 25, followed closely by Europe with eight.

Here are the Top 10 companies by market value:

1. Petro China, China, $524 billion *
2. Exxon Mobil, USA, $460 billion
3. General Electric, USA, $339 billion
4. Gazprom, Russia, $310 billion
5. China Mobile, China, $290 billion *
6. Microsoft, USA, $266 billion
7. Ind. & Comm. Bank, China, $264 billion *
8. Petrobas, Brazil, $231 billion
9. Royal Dutch Shell, Netherlands, $221 billion
10. AT&T, USA, $214 billion

While the world was riveted by news from the latest subprime fallout on July 23, few investors noticed that a leap in the share price of Industrial & Commercial Bank of China (ICBC) made it the world's biggest bank by market capitalization. On that day, the Chinese bank exceeded the $251 billion capitalization of Citigroup for the first time. Since then, the gap has only widened.Chinese banks are arguably the single-best example of successful rebranding in recent financial memory. And the transformation has been both swift and impressive. As recently as 2005, the Chinese chairman for Citigroup Global Markets Asia observed at the Wharton China Business Forum, that: "The four major state-owned banks (in China) are technically insolvent... they have weak governance, bureaucratic cultures and staggering levels of non-performing loans." He could not have guessed that within 24 months, the largest of these 'technically insolvent' banks –- ICBC -- would have not only launched the largest IPO in history ($22 billion), but also would have a market capitalization larger than Citibank itself.

Chinese Banks: A Reality Check

Eye-popping market capitalizations and slick rebranding notwithstanding, Chinese state-owned banks are a financial disaster that makes the U.S. current subprime sector look like a rounding error. Estimates of bad loans on the books of China's banks by the leading rating agencies in the world range from 40% to 60% of China's current GDP. That would be the equivalent of about $5.6 to $8.4 trillion of bad loans in the U.S. banking system in a $14 trillion economy. By way of comparison, the U.S. Savings & Loan scandal of the early 1990s cost the U.S government less than 3% of GDP. No wonder that Moody's Global Credit Research rated the average bank financial strength rating of E+ for Chinese banks, one of the lowest on Moody's global scale. Yet the irony of the focus on Chinese banks' exposure to U.S. subprime loans, which Moody's estimates to be a mere $13.5 billion, has eluded the mainstream media.
How did Chinese banks get into this mess? Investors forget that China is a Communist, centrally planned economy -- complete with five-year plans. As in all centrally planned economies, China's state-owned banks' role is to bankroll the government's massive infrastructure projects and to keep otherwise bankrupt, state-owned enterprises afloat. That's why state-owned enterprises account for 25% of gross domestic product, but receive 65% of loans. Credit management problems, a lack of qualified staffers and deep-rooted corruption are more characteristic of China's banks than world-beating financial savvy.

Chinese Banks: Smart Money's Big Bet

Yet despite their more than cosmetic defects, Chinese banks have attracted many eager suitors over the last two years. The Royal Bank of Scotland paid $3 billion for a 10% stake in the Bank of China just last year. Other banks rolling the dice in the China bank craps table include Bank of America, Citigroup, Goldman Sachs, and UBS. The initial public stock offerings (IPOs) of ICBC, Bank of China, China Construction Bank Corp., Bank of Communications Ltd., and China Merchants Bank Co. have raised more than $47 billion from share sales since June 2005. It turns out that many Western banks bought these stakes as an option on Chinese growth, regardless of the underlying asset quality. Operating in the midst of a four-year investment boom that has powered annual economic expansion of 10+% meant that Chinese banks have never had it so good. Breakneck economic growth covers a multitude of sins. Indeed, the growth in profits of Chinese banks is impressive. ICBC's first-half net profit rose 62% from a year earlier to US$5.4 billion, boosted by higher interest income and an expansion of its fee-based businesses. Bank of China's net profit for January-June rose 52% to $3.9 billion. And those who have invested early have seen their original stakes double or even triple in value. It's always hard to argue with a skyrocketing share price.

Chinese Banks: Looking Below the Hood

China bulls will argue that -- thanks to a combination of capital injections and improved operations -- a bank like ICBC has cut its non-performing loan ratio to about 4% from a high of 34%. Yet the ability of the Chinese banks to change their stripes so quickly and emerge as global powerhouses virtually overnight is doubtful. Moody's notes that many former non-performing loans have been simply re-classified as "special mention" and often represent a huge part of Chinese banks' borrowing activity. Record profits are fueled by record loan growth. New loans totaling 3.08 trillion yuan (409.6 billion U.S. dollars) were approved in the first eight months of this year, a figure that already almost matches 2006's total level of 3.18 trillion yuan (422.9 billion U.S. dollars). Of course, making bad loans only increases the level of bad debt. And the bailout money pumped into banks to dress them up for IPOs is a classic moral hazard. Jawboning from the Chinese authorities aside, there is little incentive for Chinese banks to avoid lending to state-owned businesses that show scant regard for risk or return.

Chinese Banks: Danger Ahead

The reality is that once the Chinese locomotive slows, the risk of bad loans skyrockets. The rating agency Fitch estimates that even in a moderate economic slowdown, 10% of loans could turn bad. A severe slowdown -- say, if China's GDP growth slumps to 3-4% a year -- would send the entire banking sector into a tailspin. And the repercussions are likely to be much worse -- and the bailout much more expensive than after the last bust. Loans to the Chinese private sector and non-financial government enterprises now are clocking nearly 160% of gross domestic product versus about 120% in 2000. A back-of-the envelope calculation shows that much of China's $1.3 trillion in reserves could be eaten up by banking bailouts.
As one analyst put it, "China's leaders make loud and frequent noises about how they are pushing ahead with the reform of the country's government-controlled banking system. But many Western bankers say that it could take as long as 15 to 20 years before the banks develop a Western-style credit culture and efficient operations." Here's the problem. This analysis was published in the International Herald Tribune on April 22, 1995 and it's now close to 15 years later. The world's #1 subprime problem won't disappear overnight.

The Chinese vessels "shadowed and aggressively maneuvered in dangerously close proximity" to the USNS Impeccable, an unarmed ocean surveillance vessel, with one ship coming within 25 feet, a U.S. Defense Department statement said. Tropical Hainan, less than 100 km (60 miles) south of the mainland, hosts a Chinese naval base that houses ballistic missile submarines, according to independent analysts. An unnamed spokesman for the Chinese embassy in Washington earlier denied the Chinese ships had violated maritime rules and said U.S. ships had been conducting illegal surveying, the website of Hong Kong-based Phoenix Television (news.ifeng.com) reported. It said the incident happened 120 km (70 miles) south of the island. Ma said there were laws about scientific research in Chinese waters. The U.S. ship "violated the relevant international laws and Chinese laws and regulations," he said, urging the United States to halt such action. U.S. defense officials said the incident followed days of increasingly aggressive Chinese conduct in the area, including fly-bys by Chinese maritime surveillance planes. It comes just weeks after the two sides resumed military talks, postponed in November after a U.S. announcement of arms sales to Taiwan, a self-ruled island China claims as its own. And it echoes a stand-off in 2001 between U.S. and Chinese military forces after a U.S. spy plane made an emergency landing on Hainan after a collision with a Chinese fighter jet.

China released 24 crew after a U.S. expression of regret. China's national parliament, now in annual session, is set to approve a military budget increase of 14.9 percent more than spending in 2008, bringing announced People's Liberation Army funds to 480.7 billion yuan ($70 billion). Many foreign experts believe its real budget is much higher. Some of that extra money may go to developing China's first aircraft carrier -- the trophy ship of an ambitious sea power -- senior naval officers have recently suggested. "Go and ask the Americans, ask their embassy," Vice Admiral Jin Mao, former Navy vice commander in chief, told Reuters on the sidelines of parliament when asked about the incident. "Ask their officials what their ship was doing in Chinese waters." The Impeccable is one of five ocean surveillance ships that serve with the U.S. 7th Fleet, based in Yokosuka, Japan. The ships use low-frequency sound to search for undersea threats including submarines, a U.S. military official said. A U.S. Defense Department spokesman said the Chinese vessels had surrounded the Impeccable, waving Chinese flags and telling the U.S. ship to leave. The Pentagon also described accounts of half a dozen other incidents dating back to March 4. Oil prices rose on news of the jostling on Monday and stayed high on Tuesday, although analysts said it was hard to see how the tension could threaten oil supplies or inflate prices. "I can see the geopolitical risk between two producing countries. But the U.S. and China are two major consumers. I don't know why oil prices would rise on that," said Tony Nunan, risk management manager at Tokyo-based Mitsubishi Corp. The confrontation coincides with two sensitive anniversaries in Tibet, making China especially sensitive to outside scrutiny. Analyst Shi said the seas off Hainan were important to China's projection of its influence with a modern naval fleet. "The change is in China's attitude. This reflects the hardening line in Chinese foreign policy and the importance we attach to the strategic value of the South China Sea."

Chinese ships surrounded and harassed a Navy mapping ship in international waters off China, at one point coming within 25 feet of the American boat and strewing debris in its path, the Defense Department said Monday. The Obama administration said it would continue naval operations in the South China Sea, most of which China considers its territory, and protested to China about what it called reckless behavior that endangered lives. At one point during the incident Sunday the unarmed USNS Impeccable turned fire hoses on an approaching Chinese ship in self defense, the Pentagon said. At another point a Chinese ship played chicken with the Americans, stopping dead in front of the Impeccable as it tried to sail away, forcing the civilian mariners to slam on the brakes. "We view these as unprofessional maneuvers" and a violation of international law, Pentagon spokesman Bryan Whitman said. The incident had overtones of spycraft, but the U.S. ship is not, strictly speaking, a spy ship. It maps the ocean floor with sonar, compiling information the Navy can use to steer its own submarines or track those of other nations. The Impeccable was specifically designed to augment the Navy's anti-submarine capability, although military spokesmen would not be specific about the ship's duties when it was surrounded. A Pentagon accounting of the confrontation documents the actions of the startled and cornered American crew as a Chinese vessel closed to within 25 feet. Pictures released by the Navy give a sense of the surreal scene: The Chinese mariners had stripped to their underwear following the blast by the Impeccable's fire hoses.

Whitman called that "immature," and said the confrontation was the most aggressive of a series of incidents recently in the same area. Impeccable's crew radioed to tell the Chinese ships that it was leaving the area and requested a safe path to navigate, the Pentagon said. But two of the Chinese ships stopped directly ahead of the Impeccable, forcing it to an emergency stop, the U.S. account said. The Chinese also dropped pieces of wood in the water in Impeccable's path. The incident came just a week after China and the U.S. resumed military-to-military consultations following a five-month suspension over U.S. arms sales to Taiwan. And it came as Chinese Foreign Minister Yang Jiechi was due in Washington to meet with U.S. officials. "We're going to continue to operate in those international waters, and we expect the Chinese to observe international law around that," White House press secretary Robert Gibbs said. A protest was lodged with the Chinese government by the U.S. Embassy in Beijing over the weekend and was repeated to a Chinese defense attache at a Pentagon meeting Monday. In Beijing, Chinese officials did not immediately respond to voicemail messages and e-mail regarding the U.S. allegations. Pentagon officials said the incident followed "increasingly aggressive" acts by Chinese ships against the Impeccable on Wednesday and Saturday and against the USNS Victorious surveillance ship on Thursday while it operated in the Yellow Sea.