Over the weekend, Egyptian election officials confirmed that the Muslim Brotherhood (MB) candidate, Mohamed Morsi, had won the recent presidential elections held on June 17^th.  Although this is a historic victory and event, perhaps the first real election in Egyptian history, the win must be framed within the rapidly changing political situation in Egypt. 

On June 14^th, the Egyptian Supreme Court voided the election of one third of the seats in parliament.  Shortly after the ruling, the military moved in to prevent the remaining legislators from convening.  Three days later, as Egyptians voted for president, the Supreme Council of the Armed Forces (SCAF) amended the constitutional declaration put in place last year, taking control of the legislative process and, more importantly, the writing of the constitution.  Essentially, the military has stepped in to retake control of Egypt. 

In this report we will begin with a geopolitical history of Egypt, concentrating on the unique geography that has historically shaped its governance.  We will discuss the role of the military in Egyptian political life, focusing on its self-perception and its goals.  We will also detail the role of the MB as an organized political group in the country.  Following this analysis, we will offer our forecast for Egypt and its potential effects on the region.  Finally, we will offer our expectations on how the financial and commodity markets will be affected by this situation.

  

The Geopolitics of Egypt

We define geopolitics as the study of the exercise in power within a particular geography.  In essence, basic government structures develop, in part, due to the particular geography.

The key geographic feature of Egypt is the Nile River.

(Source:  Wikipedia)

This map shows the population density of Egypt.  Most of the nation lives either along the river or in the Nile delta.  Although the country is large, the area of inhabited land is about the size of Belgium.  The Nile Valley offers a slender area that supports habitation; the rest of the country is desert. 

 

As a result of this particular geography, Egyptians have been isolated for most of their civilization.  Unfortunately for Egyptians, both ancient and modern, the Nile isn’t particularly easy to navigate.  Unlike the Mississippi River, for example, the river isn’t very straight and is often bisected with small islands.  Instead of being able to use the Nile for cheap transportation, Egyptians were forced to move products by land along the narrow fertile area around the river.  This was an expensive proposition; in fact, because the river acted as a natural dividing feature, capital investments were often duplicated on both sides of the river. 

This feature reduced the natural abundance of the region.  This isn’t to say that Egypt didn’t benefit from the Nile.  The river valley is unusually fertile, with annual floods depositing sediment that refreshed the soil.  However, few trees grow there, which were necessary for shipbuilding.  Thus, Egypt has tended to be a land power, as opposed to a naval power.

Scarce resources that were expensive to move led to centralized authoritarian regimes that marshaled the area’s assets and wealth.  The Pharaohs ruled with a heavy hand and built monuments to themselves with slave labor.  Ancient societies that faced few outside enemies tended to focus on culture instead of industry; thus, Egypt’s surrounding deserts provided a protective isolation that allowed it to develop a unique and rich culture.

Despite the desert terrain, outsiders could invade Egypt from all four directions.  The most difficult are the south and west.  Only one power, the Nubians, were ever able to invade from the south.  No power has ever successfully invaded from the west (although German General Erwin Rommel came close).  The most likely invaders came from the north, via the Mediterranean, or from the east.  Numerous ancient and recent invasions have occurred from these areas.  However, most outside powers ended up giving local Egyptian officials significant autonomy, again due to the isolation brought by the desert surrounding the Nile Valley. 

The British took control of Egypt in 1882.  The French started building the Suez Canal in the 1850s, completing the project in 1869.  It took about three years for canal traffic to rise, but soon the canal became a key global waterway.  Britain eventually took control of the canal, which was a key link to its premier colony in India.  The British held the canal until 1956, when they relinquished control to the Egyptians after the Suez Crisis. 

Recent Geopolitics

In 1952, Col. Gamal Nasser led a coup against the British-installed King Farouk.  Nasser led a group of young military officers to oust the king.  He had the support of the military and religious groups; however, to consolidate power and run a secular government, he turned on the religious powers, including the MB, making their political activities illegal. 

After taking control, Nasser was forced to choose which superpower to align with.  This need is due to Egypt’s geopolitical position—because Egypt isn’t a naval power, a nation with a strong navy can essentially bottle up Egypt.  Thus, Egyptian governments need to be friendly with the leading naval superpower.  After WWII, it was unclear which nation would take that superpower role.  Nasser decided that the Soviet Union, which appeared ascendant at the time, was a safer bet.  This decision in the mid-1950s led the British and the U.S. to withdraw support for Nasser’s pet project, the Aswan High Dam.  To continue the project, Nasser petitioned the Soviets for support and nationalized the Suez Canal in order to capture its revenues.

The British were furious with the nationalization and, along with the French and Israelis, developed a plan to recapture the canal.  The plan was successful militarily, but was an economic and political disaster.  The Eisenhower administration opposed the actions of the French, British and Israelis and threatened to precipitate a run on the British pound.  American economic power forced the three to withdraw and put the canal under U.N. protection.  The Suez Crisis made it very clear that European colonial powers were losing their former influence and the world was rapidly coalescing around the U.S. and the U.S.S.R.

Although Nasser had sided with the Soviets, the two Arab Israeli wars in 1967 and 1973 made it clear that Egypt had befriended the weaker superpower.  After Nasser died in 1970, Anwar Sadat became president.  Sadat softened his stance towards religious groups compared to Nasser, although he was not inclined to give political power to these groups.  He also attempted to open negotiations with Israel; the latter, still heady from their smashing military victory in 1967, felt little pressure to talk. 

The Yom Kippur War in 1973 was an attempt to force Israel to negotiate.  The campaign was an initial success for Egypt but Israel, with the backing of the U.S., eventually prevailed.  In the aftermath of the war, Sadat ended relations with the Soviets and gained the support of the U.S.  Over the next six years, Israel and Egypt settled the aftermath of the 1973 war and, at Camp David in 1979, a peace treaty with Israel was signed.

By agreeing to peace with Israel and gaining the support of the U.S., Egypt was protected from outside invasion.  Since most invasions had come from the east, including the two Israeli wars, securing peace with Israel was critical to Egyptian security.  And, by siding with the U.S., the protector of Israel and the global naval superpower, Egypt would face no threat from the north.

Unfortunately, the treaty was wildly unpopular in the Arab world; the Arab League expelled Egypt and moved its headquarters from Cairo to Tunis.  Egypt was not re-admitted into the league until 1989. 

Although most Egyptians supported the treaty, there were some among the Islamists who strongly opposed making peace with Israel.  A group of these Islamists penetrated the armed forces and assassinated Sadat in October 1981.  Hosni Mubarak, his vice president, took power. 

Since 1952, Egypt has been run by a series of military leaders—Nasser, Sadat, Mubarak and now, Field Marshall Tantawi.  To a great extent, these military leaders rule in a fashion similar to the ancient Pharaohs.  They supervise an authoritarian regime with heavy government control of the economy in order to marshal scarce resources to support the population.  Although Morsi’s election could signal a new era, we have serious doubts that much has changed. 

The Muslim Brotherhood

In the late 1920s, the MB was founded by Hassan Al-Banna; his organization was designed to use the Quran and Sharia to frame society.  The MB’s goal is to create a government shaped upon a conservative (mostly Sunni) form of Islam.  Al-Banna opposed colonization and generally supported democracy within the bounds of Sharia.  In social relations, the MB is generally conservative; it holds that genders should be separate.  Al-Banna considered the MB a movement and not a political party, but followers soon realized that the tenets of the MB could be implemented politically. 

A prominent figure who clashed with Nasser was Sayyid Qutb, an Egyptian intellectual and leading thinker within the MB.  He pushed a purist version of Islam and his writings are popular among primary al Qaeda figures.  Qutb studied in the U.S. from 1948-50 and came away with a very negative view of America and the West.  Qutb formally joined the MB in 1950. 

The MB was courted by Nasser and the group supported the coup.  However, Nasser wanted to create a secular state and turned on the MB.  Qutb was arrested on trumped up charges in 1954 and was held for a decade.  He was reportedly tortured during his imprisonment.  During his incarceration, he wrote two major books, In the Shade of the Koran and Milestones, which became cornerstone works for Islamists.  He was re-arrested, charged with treason and executed in 1966.

The MB has been persecuted and oppressed for most of the past 50 years.  It renounced violence in the 1970s and has tried to accommodate itself to the power structure in Egypt.  A key characteristic of the MB is patience.  Despite heavy oppression, it has managed to remain a force in Egypt.  A core organizational belief is that it will eventually win out and setbacks are not fatal. 

Although the focus of this report is Egypt, it should be noted that active MB bodies exist in most Arab states and some European nations.  Renouncing violence was not taken well by some MB members who split off to create new groups, such as al Qaeda and Islamic Jihad.  In Egypt, the MB has steadily developed a strong following and is a well-defined political force. 

The Viewpoint of the SCAF

In the Nasserite tradition, Egypt is governed by a non-political officer class; membership in that class comes from merit.  The economy is also dominated by the military; after the Israeli peace accord, the military did not face any serious outside threats.  Thus, the military leadership decided to focus on taking control of major industries.  Under Nasser, the government, following socialist principals, nationalized numerous industries.  However, under Sadat and especially Mubarak, the military became the primary controlling body of these industries.  Finally, the military budget was not reviewed by any civilian body.  The military has evolved into a “state within a state.”

The military does not necessarily desire to be “front and center” in running the government.  It prefers to remain behind the scenes and manipulate the political system quietly.  In part, this is due to the fact that the military doesn’t want to be criticized for the lackluster growth in the economy.  In addition, it wants to maintain its privileged position without having to place this arrangement under the scrutiny of the political process.  Thus, the military only gets involved in politics when it appears that order is dissolving or when its role in society is threatened. 

The Arab Spring and the Counterrevolution

The Western media has portrayed the Arab Spring as a series of indigenous uprisings against oppressive governments in the Middle East.  This interpretation is partially correct.  Indeed, the uprising was usually sparked by young people using the power of social media to organize protests against the state.  The use of social media not only allows protest leaders to easily plan collective actions but it gives the movement an air of international coordination.   However, a number of commentators have noted that social media is good at creating uprisings but it’s not very effective in exercising political power.  

In Egypt, massive protests against the Mubarak regime appeared to lead to the
Egyptian leader’s ouster.  However, behind the scenes, Mubarak was facing intense pressure to leave office from military leaders.

The military class was growing increasingly uncomfortable with Mubarak’s grooming of his son, Gamal, to take over his position.  As noted above, the Nasserite ideology was based on merit; it did not include dynastic succession.  Making matters worse, Gamal had no military experience.  Military leaders found Hosni Mubarak’s moves to promote his son as inappropriate.  Finally, Gamal had been spearheading moves to privatize some industries which were under the control of the military.  This action was seen as undermining the military’s control of the economy. 

Thus, the SCAF viewed the protests as a grassroots movement to prevent Mubarak from breaking with the Nasserite ideology.  Military leaders used the protests as a way to oust Mubarak; from the SCAF’s perspective, once Mubarak was removed, the reason for the protests was over. 

As noted above, the military has little desire to overtly run the country.  Instead, it wants virtual autonomy to operate its budget away from prying civilian eyes, to control large swaths of the economy and to represent the only body in Egypt not tainted by self-interested politics.  It wants to control the government but has no interest in operating the government day to day. 

At the same time the Egyptian youth thought it was overthrowing the regime singlehandedly, the MB and other Salafist parties were organizing.  Thus, as the military government organized the creation of a new civilian government, the Islamists organized their members for the upcoming elections.  The military seemed to believe that, due to their “heroic” actions to bring down Mubarak, they would be rewarded by getting the most votes.  In fact, the MB and other Islamic groups took over 70% of the seats in parliament.

In response to SCAF fears that the Islamists would capture both the parliament and the presidency, meaning the military would lose control of the political process, the military-dominated Supreme Court essentially disbanded parliament by declaring roughly one third of the seats won in the election as illicit.  In the interim constitution, one third of the seats are expected to go to independents.  The court decided these seats went to party-affiliated candidates and were thus illegitimate. 

At first glance, the counterrevolution appears to be a military-fostered event.  However, there is an element that has also been quietly supported by the MB.  In a sense, the “old guard” is both the Nasserite military leadership and the MB.  Neither side wants to give control to the other but neither side wants to see the “others,” the secular parties and Christians, gain power either.  Thus, the counterrevolution appears to be the military and the MB deciding how to allocate power. 

In the coming weeks, the military and the MB will be trying to set the parameters of power.  The military will want to protect its current prerogatives whereas the MB will be trying to gain as much political power as possible.  Although a rupture and civil conflict are possible, the most likely outcome will be a period of years where the two groups vie for power.  Neither side wants to see civil order deteriorate; the military has too much at stake in that they have run the country for a long time while the MB is on the cusp of gaining power.  The latter won’t threaten civil order unless it views the military’s action as preventing the MB from getting any power. 

In the short run, the primary risk to civil order in Egypt comes from the marginalized groups, the secularists, the young and the more radical Islamic groups.  Although they could form a significant block, the groups generally don’t work together and face significant internal divisions.  The MB would probably support a military crackdown on protests from these groups.

The Rest of the Region

Egypt is an important Arab nation.  When Mubarak was ousted, it added credence to the notion that the Arab Spring was an important trend.  Although an MB president is a historical event, it appears that the SCAF is still in charge.  Thus, for now, not much has changed.

We do note that the Gulf kingdoms have pledged aid to the Egyptian government but have failed to deliver due to worries about political stability in Egypt.  This weekend’s election results probably mean that the aid delays will continue as the Arab kingdoms loath the MB.  Although ostensibly religious, Saudi Arabia, Kuwait, the UAE, et al, support religious leaders insofar as they support the kingdom.  The writings of Qutb suggest regicide is an acceptable outcome, which the current kingdoms oppose.

The Obama administration has mostly supported the MB and the election process.  The U.S. provides significant funding, and threats to cut off these funds probably encouraged the military to allow the MB to claim its victory. However, an Islamist government in Egypt is probably not in the best interest of the U.S. and so we expect quiet support for the MB and the military sharing power, with the latter more dominant. 

For Israel, the election outcome is unsettling.  The peace accord with Egypt has allowed Israel to have a relatively undefended southern border; if the MB does become an enemy, the costs to Israel would rise significantly.  Even more of a concern is that Hamas, which controls the Gaza Strip, is an offshoot of the MB.  Whereas the Mubarak government generally suppressed Hamas, it would be reasonable to expect the MB to support the group.  And, the military may allow that to occur to give the MB the illusion of power. 

Although the change in Egypt is probably more perceived than real, we do expect a high degree of concern from the rest of the region over developments in Egypt.  Essentially, until regional powers can determine how Egypt will act going forward, expect concerns to remain elevated.

Ramifications

The SCAF’s decision to retake control of Egypt’s political system was not surprising.  A true surprise would have been the military allowing a real democracy to develop.  The SCAF would be perfectly comfortable with allowing the trappings of democracy to be established as long as there was no civilian control of the military, its budget or its industrial holdings.  What recent actions have shown is that the SCAF was worried that real change might occur which it had no intention of allowing. 

As we noted above, from the perspective of the SCAF, the military is the only institution that is able to manage Egypt on a disinterested basis.  While it is rather easy to dispute this claim of selflessness (as many military figures, including Mubarak, have sizable wealth), the fact remains that the military holds this position and views any dissention as disloyalty.

Although there is a risk that unrest could rise, it appears the SCAF has decided that the political process has gone on long enough and order needs to be restored.  The only real threat to the military is the MB.  However, the Brotherhood has suffered through decades of repression and would likely prefer to avoid a repeat of that fate.  Thus, the MB and the military will likely create spheres of control with the latter maintaining most of the power.  The risk to the SCAF of taking this step is that it could be held accountable for weak economic growth.  Thus, we would expect the SCAF to give the MB some semblance of power which will allow the MB to be blamed for disorder or economic weakness.

For investors, what is occurring in Egypt is a reminder that emerging markets always carry a degree of risk that is usually absent in developed markets.  For now, we would avoid investments in Egypt.  Although there may be a sharp relief rally that will look impressive if one believes that real change has occurred in Egypt, it is doubtful the rally will have “legs.” 

 

Bill O’Grady

June 25, 2012

 

This report was prepared by Bill O’Grady of Confluence Investment Management LLC and reflects the current opinion of the author. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

 

 

(c) Confluence Investment Management 

www.confluenceinvestment.com

 

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