By Eric Vandenbroeck and co-workers

Today European states are manoeuvring aggressively with and against each other to seek out their national interests. Here is a handful of examples: splits between Europe’s southern and northern states over the strength of the euro and the independence of the European Central Bank (ECB), Poland’s refusal to authorize trade negotiations with Russia despite a change in government, France’s attempts to politically isolate Germany within Europe’s decision-making structure and splits in opinion over the expansion of NATO into the Russian frontier. All these and more are far more reminiscent of the structure of European relations in 1910 than in 2000.

Looking forward, Europe already is buzzing about Paris ’ six-month turn at the EU helm in the last half of 2008. While formally the presidency is about advancing some common EU goals, France ’s primary concerns — immigration control, reining in the independence of the ECB and limiting German capabilities — are more about serving French national interests.

Regional trend: Should it occur over Russian objections, Kosovar independence would deliver a massive blow to Russian credibility. Thus, Kosovo will serve as the litmus test for either the return of Russian power or a surge in the West’s expansion.

Kosovo’s Feb. 17 independence has so far not been met with any dramatic shifts in Russian positions, much less any serious push back against Western influence. In fact, the only thing Russia has done is attempted to band together the Commonwealth of Independent States more tightly. Such tactical and defensive moves will do little to convince the West that Russia ’s positions should be taken seriously, much less address the West’s cooperation and coherence in reducing Russia ’s influence in its periphery.

It is in this context that the April 2-4 NATO summit occurred. Even as the return of the Concert of Powers weakens the solidarity of the European Union, NATO coherence is moving in the other direction. In part this is because France, which will fully rejoin the alliance by year’s end, wishes to hedge its bets against a strengthening Germany . In part it is because many European states recognize that NATO, not the European Union, allows the greatest likelihood for Europe punching above its weight on the international stage. In part it is because the Europeans are alternatively scared of or not impressed with Russian power. So expanding NATO into the Balkans — and even flirting with membership talks with Georgia and Ukraine — is either the equivalent of an insurance policy or kicking Russia while it is down. In the weeks ahead a similar logic will seal up deals on ballistic missill defense.

Russia is in the most threatened position it has been in since 1998 when the financial crisis crippled it economically and Western unilateral actions in then-Yugoslavia made a mockery of Russian political and military power. For Eurasia , therefore, the second quarter hinges on Russian President Vladimir Putin’s ability to respond to his country’s newfound isolation.

Putin’s task is a difficult one. While Russia is hardly a weakling, the West is not sitting idle. While at the NATO summit Russia was fully focused on limiting NATO membership expansion, Washington formalized a process for hooking NATO members into its missile defense system. While Russia claims it won the victory at the summit, that victory will be short-lived. NATO appears to have set itself up for larger and more long-term moves to constrain Russia ’s power.

Regional trend: Russia ’s internal power struggles will hamper Moscow ’s ability to pursue its international agenda.

But despite obvious desires, the Kremlin is very unlikely to strike back in the near term. In the second quarter, Dmitri Medvedev will assume the presidency while Putin steps into the prime minister’s position. This transition — while more in form than in substance — has sufficiently shaken the Kremlin power structure so that the second quarter will be one of seething and seeking in Moscow as various power groups scheme and strike against each other.

The group that bears the most watching is the Federal Security Service (FSB). A central pillar of Putin’s control of the Russian system these past eight years has been regular reorganizations to keep the various power players at each others’ throats so that they do not have the freedom to conspire against him. But in order to strengthen Russia ’s international position, there has been one exception: the intelligence services. Rather than shatter them, Putin has instead consolidated them almost exclusively under the FSB. And now the FSB is a robust political force in and of itself — and it believes that one of its own should succeed Putin as president. The risk of a coup or something like it — while not high — is certainly on many minds.

In the end, we expect Putin to successfully migrate his personal position as Russia ’s central power broker to his new office, but that will take time. Additionally, Putin will be forced — at a minimum — to spend the second quarter establishing his successor in the factions’ minds as a non-negotiable fact, while seeking a new balance of power among the institutions and factions that compose the inner workings of the Kremlin. Success in this latter task is not guaranteed by a long shot.

But even in the unlikely scenario of a coup against Medvedev and/or Putin , Russia ’s geopolitical imperative to seek to roll back Western advances by reasserting Russian influence throughout the former Soviet space remains. The question is how much energy Russia can expend on that goal — which in the second quarter will be nil — not what the policy preference will be.

New regional trend: Serbian elections will end Belgrade ’s position in geopolitical no-man’s-land — one way or the other.

As discussed above, Kosovar independence has deeply affected Western-Russian relations not on the merits of the case, but for what it means for Russian credibility. On the merits, however, it will affect developments in the former Yugoslavia just as deeply.

Serbian elections, to be held May 11, will be the region’s only important vote in the second quarter. In that vote, Serbs must choose between locking themselves to a prison of anti-Western sentiment (Serbia is now landlocked and bordered on all sides by NATO and EU members, applicants and protectorates) or breaking with its schizophrenic and nationalist past and throwing in its lot with the very West that has so humiliated it. Either way, this is Serbia ’s moment of truth.

Regional trend: The Chinese government intends for the year 2008 to be China ’s day in the sun, with the Olympics showcasing how advanced and stable the country has become. This requires Beijing to act pre-emptively to prevent anyone with an interest in marring China ’s image from disrupting the Olympics.

Beijing continues taking pre-emptive measures against threats to the Olympic Games — limiting public protests, censoring both foreign and domestic media, and tightening Internet controls. It has even gone so far as to overstate threats to prepare the Han population for whatever crackdowns might be needed.

But there are plenty of real examples of others seeking to use the Olympics to cast China in an unfavourable light. Tibetan protests in March would not have been nearly so violent if not for the run-up to the Olympics. Likewise, outgoing Taiwanese President Chen Shui-bian tried to rattle Beijing by pushing a referendum to seek U.N. membership while looking to purchase F-16s from Washington.

We expect seemingly disparate activist campaigns (such as Save Darfur and Free Tibet) to coordinate their anti-Beijing activities in the hopes of linking many different regional and topical issues. To counter, Beijing will undermine such activities by lobbying foreign governments and personalities to both reduce their reception for these groups and prepare the world for crackdowns on them.

Regional trend: In order to tighten its grip on an often unstable and chaotic economy and Communist Party, the Chinese Central Committee is reshuffling the bureaucracy, with an eye to creating energy, aviation and finance super ministries directly under its control.

The March National People’s Congress formally launched the process of selecting the next generation of leadership and consolidating the Central Committee’s authority. The selection process is now mostly concluded, with Xi Jinping all but certain to take the top spot when President Hu Jintao resigns and Li Keqiang likely becomes prime minister.

But the top leadership is not of one mind on the issue of organizational consolidation, and players across the various institutions jealously guard their policy independence (and the profits that flow from it). The reshuffling process will dominate what little of the government’s attention is not held by Olympic preparations for the next several months — which means that this trend is largely boxed up until the Olympics conclude.

Regional trend: The U.S. alliance structure in Asia is being readjusted as states feel out both bilateral and multilateral relationships in order to maximize their influence in an evolving world.

The first quarter saw the defeat of the proposed successor to Taiwanese President Chen Shui-bian, the return of former Thai Prime Minister Thaksin Shinawatra to Bangkok and success for South Korean conservatives. The first event heralds a Taipei far more capable of holding a civil discussion with China , thus removing a large perennial headache and smoothing over at least one problem in presenting Beijing ’s Olympic image. The second heralds some form of normality in Thailand (which will thrill businesses). While tensions are still running high, the election results and Thaksin’s return signal some sort of compromise between the military and new government in shaping Thailand ’s future.

In both cases — and in the case with the new South Korean government — the United States is now involved in a liberal round of alliance management. It is not so much that the changes in governments have given rise to anti-American forces, but with change comes the need for a regrounding on one hand, and adjustment as the Asian states feel out new bilateral relationships with their neighbours on the other. Similar activities are in progress with the Australian and Japanese governments.

Regional trend: The Pakistani army/state will hold together even as confusion and distractions in Islamabad greatly reduce the Pakistani government’s ability (and willingness) to rein in jihadists.

February elections were peaceful and successful, and President Pervez Musharraf’s forces were decisively trounced. The reason for such a clean break —was simple: The army abandoned the president and soon could usher him from power in the event of a clash between him and Parliament.

The new order will be a weak, hybridized coalition government moving toward a parliamentary system complete with checks and balances, albeit heavily influenced by the country’s military. The most significant geopolitical result of these internal machinations will be an assertive review of the country’s terrorism policies, effectively ending Islamabad ’s reputation as a one-stop shop for U.S. security concerns. These changes will complicate U.S. operations just as militant activity along the Afghan-Pakistani border goes through its normal spring up tick, which means the insurgency will strike into Pakistan harder, deeper and more often.

Regional trend: India ’s schizophrenic policies regarding everything from tax regimes to special economic zones to basic infrastructure are proving that the idea of “Shining India ” is a myth and will lead to a waning in foreign investment.

This is a trend in progress. As of the end of the first quarter, foreign investors have not run for the door, but Indian politics are certainly not going to bolster anyone’s confidence in the second quarter. While parliamentary elections do not have to be held until May of 2009, India tends to have elections early and the campaigning has already unofficially begun. Campaigns in India are often accompanied by gridlock, violence and the utter non-responsiveness of government as all attention is directed toward re-election. Add in rising tensions throughout India ’s myriad secessionist regions, and there will be little joy for anyone relying upon India for their bottom lines.

Meanwhile, the ongoing tug-of-war between Russia and the United States over India will continue, with Moscow relying heavily on energy and defence incentives to scupper Washington ’s attempts to secure New Delhi ’s commitment as its strategic proxy in the Indian Ocean basin. India ’s domestic political squabbles will guarantee that little to no progress will be made toward the U.S.-India civilian nuclear deal, much to Russia ’s content.

Regional trend: The rest of South Asia will be consumed with domestic issues.

This prediction is, if anything, an understatement. The stalemate between the Sri Lankan government and the Tamil rebels is continuing, while Bangladeshi elections, which were supposed to occur in 2008, are now almost certain to be postponed another year. Nepal will have its elections in April as the country’s Maoists argue among themselves over how deeply they should enmesh themselves in the political system after years of rebellion. Unwilling to get cut out of the political negotiations, a Madhesi insurgency in the Terai region of Nepal will intensify. All three states will remain mired in their own troubles, only tangentially aware of what occurs beyond their borders.

That just leaves Afghanistan. While talks between Western forces protecting the central government in Kabul and elements of the Taliban continue, the bottom line is that little progress is being made on the battlefield. A surge in Western troop levels has allowed international forces to hold more ground, but even now there are fewer than half the number of troops in-country than the Soviets stationed during their 1980-1989 war. The best international forces can hope for — a strategic stalemate punctuated by regular attacks by both sides — is indeed the current situation on the ground. Neither side is capable of winning or — while both sides’ nerves hold — of losing. As a result, there will be an increased clamour in the West for dialogue with pragmatic elements within the Taliban movement.

Regional trend: Latin America is coming of age and beginning to look internally to address problems, rather than depending upon action from beyond the region (action that only rarely materializes).

Mexican President Felipe Calderon’s tax reforms have moved ahead with impressive speed, but his efforts to liberalize the energy sector have stalled in the face of Congressional protest from both of the opposition parties. Some limited progress might be made in the second quarter in terms of legalizing joint ventures in the U.S. border region — where some legal gymnastics might make foreign investment possible — and offshore with Brazilian state firm Petroleo Brasileiro, whose presence would not trigger the same level of nationalist outcry that other oil firms’ would.

A spat between Venezuela and Colombia over a Colombian foray into Ecuador in pursuit of Revolutionary Armed Forces of Colombia (FARC) members in February was solved entirely in house, with neither side appealing to even mediation from beyond their immediate neighbours. Colombia ’s efforts to remove one of its rebel groups — the National Liberation Army — from the military equation continue without any international mediation.

Even Argentina — whose indulgence in populism has brought forth high inflation, distribution failures, chronic strikes and energy vulnerability — shows not even a hint of a tendency to seek outside assistance. Very soon the government will need to either buckle down and do the painful reforms necessary to stabilize the economy or risk an economic breakdown. We expect that in time the government will choose the former. But, then again, it seems that such a decision would have already been made — yet the populist policies continue to flow.

Regional trend: Only one Latin American state will rebut the trend to seek self-sufficiency: Bolivia.

In essence, Bolivia is flirting with civil war.

The richer but less populated lowlands have been resisting the rising power of President Evo Morales — whose support base is among the poor, indigenous highlanders — as he attempts to consolidate power in this notoriously fractured state. The lowlanders are now exporting their products in ways to eliminate tax-taking by the central government. The clash between the two regions — which is often higher in drama than octane — will accelerate in May when the lowlands vote in an independence referendum, despite a federal court ruling that has already declared it unconstitutional.

This will throw down the gauntlet to Morales and force him to consider military action, an arena in which he holds the upper hand — the lowlands, used to holding political control, do not have a history of militancy. But, even in the best-case scenario for the president, a military resolution will not happen easily or quickly — and is unlikely to happen until all political options are exhausted.

Regional trend: Brazil is rising as the continental hegemon of South America.

Via state-linked energy firm Petrobras , Brazil is steadily deepening its ownership of energy infrastructure in Bolivia , Paraguay and Uruguay — a policy that will soon be extended into Argentina as that country’s situation degrades. While all these decisions make economic sense on their own merits, the investments serve another purpose: extending de facto Brazilian control throughout the Southern Cone.

Brazilian influence is not only spreading south. President Luiz Inacio “Lula” da Silva has already manoeuvred Brazil to be the central power in determining the future of post-Castro Cuba . Brazil took advantage of the Colombian-Venezuelan disagreements in March to insert itself as the central mediator in the continent’s security conflicts. Brasilia will spend much of the second quarter leveraging its already impressive economic power in an effort to force the region to recognize it as the region’s political leader under the aegis of the South American “Security Council” — a group that Brasilia envisions as a Brazil-led forum for dealing with regional issues.

Regional trend: Venezuela ’s Hugo Chavez faces the greatest challenges to his rule in his 10 years as president, largely due to the rising unity of the country’s notoriously fractured opposition.

In the first quarter, Chavez acted as a man under extreme pressure when he picked a fight with Colombia that he had no hope of waging, much less winning, in order to stir up nationalist sentiment. He is similarly engaged in a legal tussle with ExxonMobil, which could cost Venezuela dearly in terms of cash and assets.

Ten years of populist policies have fundamentally damaged the Venezuelan economy, resulting in surging inflation and food shortages — developments that often sound the death knell for Latin American governments. To address these issues in the second quarter, Chavez will move against select foreign energy interests to scrape together more financial resources, attempt to force domestic food producers to increase output (or simply confiscate property) and rally to the FARC’s defence in an effort to maintain nationalistic support.

The common thread in all of these reactive policies is Chavez’s fear of the country’s steadily uniting opposition. But after visiting remarkable defeats upon Chavez in 2007, opposition efforts have largely stalled so far in 2008. If Chavez can shift from reaction to crackdown, he will be able to alleviate the sense of desperation that currently pervades the government and break the opposition’s back.

Regional trend: In contrast to previous years, there will be little direct involvement of the major outside — or even inside — players. The one exception will be Angola , which will enjoy a rare day in the sun as the continent’s up-and-comer.

If anything, this has proved to be an understatement. China is obsessed with the Olympics, Russia with NATO expansion, India with elections and the United States with the Middle East . Of the major global powers only Europe is playing in the African sandbox in any real way, and that is largely limited to the French-led stabilization force it is dispatching to Chad — a force that will desperately try to keep its head down.

Even within the continent, local players are locked down in internal affairs. Nigeria is attempting to put its stamp of authority on the restive Niger Delta, an effort we expect will prove reasonably successful now that someone from that region — Goodluck Jonathan — holds the vice presidency. The result will dial back violence and oil disruption issues to lower levels than have been seen over the past three years.

In South Africa , President Thabo Mbeki is slowly being edged out of governance by his almost-certain replacement, Jacob Zuma. The combination of the political transition and a chronic electricity crisis eliminates all bandwidth in Pretoria for international adventurism.

Elsewhere, African developments are reverting to a steady state. In Somalia , neither the Ethiopians nor the Somalian Islamists are positioned well to win the war. The Ethiopia-Eritrea stalemate will continue, with war not particularly likely. In Kenya , the tribal splits exacerbated by elections that occurred at the very end of 2007 are here to stay, but urban politicians have already divvied up the political spoils, so any violence should fall to background levels and be restricted to the countryside, largely in the western part of the country.

Even in Angola — the one country we highlighted in our annual as being in a position to push out — introspection is sinking in. The government is busy ensuring that it will be able to decisively win September parliamentary elections (the country’s first since 2002, and an event that will lay the groundwork for presidential elections to be held, possibly in 2009). Luanda also is making sure rebel groups in the country — including the National Union for the Total Independence of Angola in the country’s central highlands and rebels in the country’s oil-rich Cabinda province — lack the capacity to threaten the ruling regime’s grip over the major urban regions and the country’s two critical bases of wealth: its oil and its diamonds. But uniquely among the various African states, Angola — gorged on its newfound oil wealth — does have the bandwidth to deal with any threats or opportunities that arise. It just will not be particularly watchful for the next three months.

The first quarter of 2008 witnessed  American successes at leveraging the U.S. Sunni alliance structure. Specifically, jihadist activity in Iraq is near its lowest level since it began in the summer of 2003, a few months after the ouster of the Baathist regime, and the Iraqi government has consolidated sufficiently to begin cracking down on dissident Shiite groups in southern Iraq . At the time of this writing, it appears Iran knows what is coming and instead of stirring up Shiite militias to secure more leverage in negotiations with Washington , Tehran is smoothing differences of opinion with the Americans to not risk losing its position in Iraq . Iran has not given up its influence — far from it. Rather, as Iraq ’s Sunnis and Kurds become more willing to work with the United States , Iran ’s willingness to turn the Shia loose begins threatening Iranian interests as well. The more the Shia fight among themselves, the weaker Iran ’s hold on the country.

That makes the second quarter (or perhaps third) the most likely one in which a final deal could be struck. The timing makes sense. Iran — having learned from Ronald Reagan what it means to wait to deal with the next U.S. president — would like an agreement before U.S. elections in November. So too (obviously) would the Bush administration. The two items left to deal on are what Iran’s final price is for not setting Iraq on fire, and how to break it to the people of the United States and Iran that the Great Satan is working with a charter member of the Axis of Evil. As the days roll by, the first of these items is becoming less of an issue as the pieces steadily fall into place while the second issue is becoming more prominent.

As Iran and the United States slide toward alignment, Syria is getting left out in the cold. Despite Damascus ’ best efforts, it has been unable to capture American attention as anything other than an adjunct to Iran — something of minimal value should Tehran and Washington come to an agreement. Syria ’s two keys to relevance are achieving an end to international isolation and securing its position in Lebanon . Syria has little to offer on the first point — indeed, much of the Arab world boycotted the Syrian-hosted Arab League summit in March.

On the second, the West sees no need to allow Syria any concessions on the topic. The result is a regime shorn of options and searching for a new strategy. Damascus has the most wiggle room in Lebanon, where it can resort to an array of intimidation tactics to attempt to manipulate local politics in its favour, but it will also search for cards to play along its border with Israel with an aggressive aim to demonstrate to Israel and the United States the costs of leaving Syria out in the diplomatic cold.

The last major player opposed to U.S. interests in the region is the Lebanese-based militant group Hezbollah. While Hezbollah desperately wishes to seek revenge for the assassination of operations chief Imad Mughniyah, it is afraid that Israel could achieve in 2008 what it failed to do in the 2006: severely degrade Hezbollah’s military capability. This leaves Hezbollah playing its cards conservatively to avoid triggering a confrontation — a confrontation that Tehran and Washington , engrossed in their negotiations over Iraq , also would prefer to avoid.

For its part, Israel is itching for a fight — but between Iranian, American and Hezbollah desires for calm, it would take a major miscalculation for one to break out.

Regional trend: Turkey is emerging as a major regional power and in 2008 will begin to exert influence throughout its periphery — most notably in northern Iraq

Turkey launched regular military interventions across the Iraqi border to hobble Kurdish ambitions. And anything shy of a strong centralized Iraqi government — which is simply not in the cards — will prevent future such interventions. (However, Turkey ’s long-standing identity crisis over the definition of secularism will complicate this trajectory.) Turkey is feeling strong not only in northern Iraq, but also in the nearby Balkans and Caucasus, where it is seeking to mentor newly independent Kosovo and a newly oil-rich Azerbaijan.

But internally all is not solid in Turkey. The guardians of Turkey ’s secular state have challenged the Islamist-rooted ruling Justice and Development (AK) party, seeking a Constitutional Court ruling that would disband the party and likely the government. The second quarter will see this drama play out as the two sides literally struggle for the future of the government.

While the AK party enjoys strong public support and holds the parliament and the presidency, the secularists control the court that will be making the decision on the ban (which could result in the Parliament’s dissolution and the president’s dismissal). In the end, odds are the AK party — or the political force that the party represents — will end up on top, but it will not be an easy, quick or clean victory. The court decision might not come in the second quarter, and even if it does a ruling against the AK party would likely force fresh elections. This domestic situation could disrupt Turkey ’s economic growth and detract from its focus on northern Iraq.

Economy

Regional trend: Oil prices will soften in 2008 due to the fading of geopolitical risks in key locations.

Obviously prices have risen — not fallen — in the first quarter of 2008. Yet many of the geopolitical factors that led to the 2007 price surge — violence in Nigeria , Iraqi instability and the possibility of an American-Iranian confrontation — are all cycling down. We look to the second — and more likely third — quarter of 2008 for this prediction to come true. If the global economy cools somewhat (see below), that too should take some of the shine off of oil prices.

Regional trend: Countries the world over will pull their energy sectors back from the free market in order to stave off social instability and/or maximize profit.

On the supply side, Venezuela will tinker with fresh nationalizations as well as another windfall tax on foreign producers. Russia will launch its effort to bring private producer TNK-BP under state control. States ranging from Kazakhstan to Angola to Libya to even the United States are changing their tax laws to increase the state’s tax take.

On the flip side, many states are asserting more control over their networks to protect sacred cows. Many European states are fighting the European Commission’s plans to break up monopolistic holdings in energy transport and distribution. China is gathering its various energy firms and agencies into a single super ministry for reasons political as well as economic. And states the world over — doubly so in South and East Asia — are paying through the nose to maintain energy subsidies and thus contain social unrest.

Even in the country where there are efforts to alter such a state of affairs — Mexico — the heavy hand of the state retains its grip, as energy reforms will remain mired in congressional opposition.

Regional trend: Despite much talk to the contrary, the United States will enjoy strong economic performance. In part, this is because of the massive inflow of money into the United States from Asian and Arabian states.

A good rule of thumb is that when the dominant financial publications are screaming about blood in the streets, an economic recovery is under way. The U.S. economic system is such that adjustments are made very early in crises, as Americans tend to overreact. We believe the worst of the current slowdown — in part triggered by the subprime mortgage issue — hit in the final quarter of 2007. It is worth noting that preliminary government statistics indicate that growth for that quarter still came in at 0.6 percent — not great, but still clearly in positive territory.

There certainly was fallout in the first quarter of 2008, but so far that activity has largely been limited to the housing and financial sectors. The first was badly in need of a reality check, and the second was responsible for financing the first. Moreover, the worst of the housing problems exploded in very discrete overleveraged and overbuilt markets — some regional recessions are certainly possible, even inevitable — but the underlying national economic bedrock remains stable. We  see the current situation as market punishment for poor decision-makers. The worst has past for the United States; there are certainly some inflation concerns, but we believe inflation will affect the developing world more than the developed world (see below).

What we find most illuminating is the split between market rhetoric and market performance. Wall Street appears convinced that the end is nigh, yet at the time of this writing, the S&P500 was only about 15 percent off of its peak. In most recessions, the major markets shed 25 percent or more of their value. We do not do not intend  to  not forecast markets, but the markets forecast future economic performance rather accurately.

Much angst and hand-wringing will remain as the financial carnage runs its course. But what is most notable about the first quarter is what did not happen: long-term interest rates did not increase (therefore, any liquidity crunch is both limited and temporary), and the markets did not crash. We  see no weakness in American economic fundamentals, and the stage appears set for a return to moderately strong growth. The one danger we are watching like a hawk is consumer confidence, which dipped at the tail end of the first quarter. In election years, politicians challenging the system –- and, remember, there are no incumbents running for the presidency — tend to talk down the economy. In the 2000 and 1992 elections, such talk contributed to mild recessions. If the subprime slowdown is to become worse, that will be why.

New regional trend: Inflation is on the rise on a global scale.

The current inflation has three causes. First, broad and deep economic growth globally has increased demand for everything from T-shirts to titanium in both the developed and the developing world — in the world of economics, this is called demand-pull inflation. Second, a variety of geopolitical disruptions — including populist policies in Argentina, snowstorms in China, energy muscle-flexing in Russia and, of course, oil north of $100 a barrel — have driven prices higher for reasons that have little to do with economic fundamentals (cost-push inflation).

Finally, the process of U.S. and global financial institutions digesting the subprime housing crisis requires that they re-evaluate the risk of their portfolios of assets more accurately. Until they are confident that they have the numbers right, they will be less likely to make new loans. This has a mixed impact on inflation, reducing the ability of consumers to make purchases (actually a deflationary trend because it threatens to create a glut of goods) while also limiting the ability of producers to produce goods (a textbook inflationary impact).

The combination of high demand, restricted supply and reduced availability of credit (although we expect this last item to reverse at some point this quarter) is not simply a recipe for inflation, but also for slowed economic activity. This is doubly the case in the weaker portions of the developing world where growth is tightly linked to production, as opposed to the developed world where services are far more important. That, in turn, is stoking fears of social unrest, especially in countries where the poor (usually hit first by increases in the price of basic necessities) make up the bulk of the population.

 

 

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