The Egyptian Coup: an Update

(Due to the upcoming Labor Day holiday and an impending office move, the next edition of the WGR will be September 16.)

Since we first discussed the Egyptian military’s ouster of President Morsi (see WGR, The Egyptian C#@P, 7/15/2013), developments have taken a serious turn for the worse. The military has moved aggressively against the Muslim Brotherhood (MB), arresting a large number of leaders and using deadly force to break up mass demonstrations.

In this report, we will update developments in Egypt and discuss how the military’s actions increase the odds of future problems. We will study the military’s goals for the coup. From there, we will examine the Obama administration’s difficult position and how the Egyptian coup has caused a divergence of responses from regional powers. As always, we will conclude with potential market ramifications.

The Coup Unfolds

As we noted in the aforementioned report, the Egyptian coup, which occurred in early July, had the characteristics of a “Civil Society Coup.” These ousters are supported by “society” against a ruling party that holds power but appears to be taking anti-democratic steps to permanently secure control. In addition, the economy is usually performing badly. What separates the Civil Society Coup from the normal coup is that the military does not instigate it, but executes the ouster at the behest of “society.” As we discussed, these civil actions usually fail to achieve their desired goals. Often, the “civil society” is simply the disloyal opposition that uses the military to overturn what they failed to achieve at the ballot box. The new government lacks legitimacy and any future government must live with the fear that disaffected groups can petition the military to oust them as well.

Immediately after ousting Morsi, the military tried to create an inclusive government. Secular liberals were, for the most part, supportive of the ouster from the start. Some Islamic groups, uncomfortable with the behavior of the MB, joined the government. Coptic Christians, who were oppressed by the MB, were enthusiastic supporters.

However, given the MB’s well-developed political machine, it is highly likely that new elections would give this Islamic group high representation. In fact, it is conceivable it would retake power. Thus, the military has developed the position that the MB must be crushed.

For the MB, the ouster signaled that the Coptics, secularists and the military would never allow it to rule even with electoral victories. The subsequent crackdown (nearly 2,000 have been killed so far) against MB encampments now indicates the military and its fellow travelers intend to destroy the MB as a political power. The MB is instigating civil unrest in an attempt to prove to opposing forces that it will not be cowed. The situation is rapidly becoming a life or death struggle for survival; this is why calls for restraint and dialogue from Western nations are being ignored.

Unfortunately, the military’s actions will most likely radicalize the MB. The Coptics, secularists and the military argue, with justification, that the MB was taking anti-democratic stances that were leading to “one man, one vote, one time.” By holding the elections first and writing the constitution after, the rule of the land was written by the victors. The notion of “loyal opposition” is clearly lacking in the region. Despite the offered justification, a radicalized MB will become difficult to contain. Although we doubt Egypt could become another Syria, such an outcome is not inconceivable. The MB could receive support from a revitalized al Qaeda (see WGR, The Embassy Closings, 8/19/2013) as well as from Turkey and Qatar, which were offering financial support prior to Morsi’s ouster.

What Does the Military Want?

The Egyptian military is reluctant to take power. It has created a “mini-state” within the country; it has its own businesses and residential areas and has little interest in trying to manage Egypt’s increasingly dysfunctional economy. The primary reason the military supported the 2011 ouster of Hosni Mubarak was due to his moves toward creating a hereditary dynasty. It was becoming clear that Mubarak was grooming his son, Gamal, to become the next president of Egypt, similar to what Hafez Assad did in Syria. The military prides itself on being a meritocracy; the idea that Hosni Mubarak was acting like a Pharaoh was repulsive.

However, beyond the discomfort with Mubarak’s dynastic ambitions, the military mostly approved of the structure of government. The military wanted to create a system that ensured its privileges would remain intact. It supported Mubarak’s suppression of Islamists, including the MB, and endorsed the heavy security presence in society.

We suspect the military would prefer to return to the structure of the Mubarak government, sans the dynastic ambitions. From the military’s perspective, this outcome is better than democracy. Their privileges are more secure because the leadership doesn’t change very often. Having a military man in power is even better because he will “understand” their needs and desires.

Given this goal, what should the military do? First, it must weaken forces committed to other forms of government. If one were trying to build a functioning democracy, the first step would be to write a constitution that reflects the will of the majority while protecting the rights of minorities. The second step would be to hold regular elections that are generally free and uncorrupt. That way, new governments will have the legitimacy of the ballot box. So, if the military was serious about “restoring democracy,” it would be working to include the MB and other jihadist groups, and ensuring that secular and Christian groups were protected.

Instead, the military seems to be moving in the exact opposite direction. Security forces appear to have declared war on the MB. Nearly 2,000 Egyptians have died over the past two weeks and much of the MB leadership has been arrested. The military seems to be committed to eradicating the MB. However, it should also be noted that on Wednesday, August 21, a Cairo court set a trial date for Mohamed el-Baradei, who had been appointed as VP of Foreign Affairs in the interim government. El-Baradei is an international figure; he was head of the International Atomic Energy Agency (IAEA) and won a Nobel Peace Prize for his role in preventing nuclear power from being used in weapons. As the bloodshed escalated, he decided to resign from his post on August 14. This resignation, which embarrassed the military, apparently triggered the arrest warrant. The fact that both the MB and a prominent secular figure have been detained suggests that the military is seeking acquiescence and anyone not willing to follow along is deemed an “enemy of the state.” The New York Times confirmed this stance on Saturday, August 24.1

Perhaps the clearest sign the military wants to return to pre-2011 is the release of former president Hosni Mubarak from prison. According to reports, he will be required to make restitution of some of his wealth on the grounds it was improperly gained and has not received a passport, meaning he cannot leave the country. Still, for a man who was facing a life sentence for his role in the crackdown against protestors during the events of 2011, this is a rather stunning turn of events. His release shows that the military is in charge and a counterrevolution is in the works to return to a form of government seen during the Mubarak era.

The American Conundrum

America has always struggled with integrating the superpower role with the republic narrative of the Founding Fathers. Americans view themselves as a nation that respects freedom and human rights against the capricious actions of tyrants. The U.S. Bill of Rights firmly establishes the rights of Americans against a myriad of government actions. This vision of America, a nation of people who are free to pursue “life, liberty and the pursuit of happiness,” is what we own.

However, the superpower has obligations that conflict with these goals and aspirations. When a nation is a superpower, it gains new enemies; foreign relationships can change. Other nations view the superpower as either a threatening force or a nation to be manipulated into acting in their particular interests. Americans, at a visceral level, tend to view nations as “friends or foes.” In reality, superpowers have no friends, just interests.

The superpower role usually requires two behaviors that are at odds with a democratic republic. First, because of the large number of enemies, the government is forced to intrude into foreign and domestic societies. Before WWII, the U.S. did not have a CIA. There was some spying from the founding of the republic but it was mostly centered on foreigners. Although the CIA charter prohibits the body from spying on the U.S. itself, it often worked with the FBI in cases of domestic espionage. The recent blowup over the NSA and data harvesting relates directly to the need to gather intelligence on potential terrorist threats. These actions probably violate the spirit of the Constitution but it should be remembered that it was written for a republic.

Second, the superpower has enormous global military responsibilities. Simply put, no nation is large enough to monitor the world alone. This means the U.S. must acquire allies in critical parts of the world. Sometimes, these allies do not meet the standards of a functioning western democracy. These allies can be autocrats, dictators and worse.2 However, in the interest of world stability, the superpower must, at times, ally with reprobates. The superpower must occasionally undermine democratic movements in friendly dictatorships to ensure stability. History shows that in the long run, democracies tend to be more stable. However, the transition to democracy can be fraught with risk.3 Often, a superpower will undermine a nascent democracy movement in favor of stability.

Often, the actions necessary to maintain America’s superpower status are at odds with our republic narrative. With regard to Egypt, our republic hearts want to support the creation of a democratic state with proper minority protections. However, there is a risk that Egypt might become an Islamic state opposed to our interests in the region. As a superpower, this outcome is fraught with danger. The U.S. has overflight privileges and our navy gets preferential treatment for passages of the Suez Canal. Undermining the military puts those privileges at risk.

So far, the Obama administration has struggled to build a coherent policy. The administration refuses to call the coup a “coup” because U.S. law requires the administration to cut off aid to Egypt. The government fears it will lose whatever leverage it has over the Egyptian military if it cuts aid. There are reports that some aid has been cut; it seems the administration doesn’t want an official declaration but does want to send a signal. Recently, annual military exercises were canceled, another attempt to express displeasure.

However, by not calling what is obviously a coup a “coup,” the Obama administration looks rather silly. The series of half measures, to a great extent, express the dissonance between the republic America aspires to and the superpower reality it lives in. The U.S. needs Egypt as long as it needs to project power in the Middle East. Another revolution like the one that occurred in Iran in 1979 would be a bad outcome. At the same time, supporting the Egyptian military in its attempt to completely eliminate the MB is clearly distasteful.

At a later date, we will revisit the “republic v. superpower” debate. The Egypt situation, along with the Snowden Affair, reveals the divergence between our republic aspirations and the hard reality of global dominance. The venue for resolving that debate is the political sphere. So far, the political class has been avoiding this discussion (and has, for the most part, since 1945). However, there is an active debate at the periphery of political discourse—it is quite possible, at some point, a connection between our superpower role and the NSA’s behavior or our tortured policy toward Egypt may bring a broader discussion.

Regional Reactions

A bloc of nations is evolving to support the generals. Saudi Arabia, the UAE, Kuwait and Israel are all rooting for the military to crush the MB and prevent it from being a political force in the future. The Arab Gulf states oppose the notion of a government that is both Islamic and democratic, fearing that it will offer its own citizens a different model than monarchial Islamic governments. Israel has never been comfortable with an MB-led Egypt, fearing it would support Hamas4 in the Gaza Strip and allow jihadist groups to operate in the Sinai Peninsula. The Arab Gulf states have promised to inject $8 to $10 bn into the Egyptian economy, overwhelming the $1.5 bn of direct U.S. military aid offered annually. The action of these Arab states undermines U.S. leverage.

On the other hand, Turkey has been supportive of the MB. Turkey does have a functioning Islamic democracy and would like to see its model expanded in the region. Such an expansion would boost Turkish influence. As expected, Turkey has opposed the Egyptian military and has pressed the U.S. to intervene. The U.S. needs Turkey as an ally; the Incirlik Air Base is a key NATO air force facility, allowing the U.S. to project air power in the Middle East. Losing Turkey as an ally would complicate American management of the region.


Overall, it appears that we are witnessing the Egyptian counterrevolution. Although there is a small chance the military may not get its way, it is more likely the armed forces will return Egypt to the Mubarak era, without Mubarak.

For the U.S., the policy struggles the Obama administration is facing on this issue are part of a larger narrative. America has not created an operating foreign policy framework since the end of the Cold War. A single superpower faces constant threats and needs to cope with multiple pressures. Without a broad framework to create working parameters for behavior, the U.S. seems to lurch from crisis to crisis. Although winning the Cold War was clearly a monumental positive outcome, the aftermath has brought major challenges that have not been resolved in over two decades. The current turmoil in the Middle East, which began to escalate with the Arab Spring, is now becoming critical. The U.S. needs to decide what its goals are for the region in the context of its superpower role. Until this occurs, American policy will continue to lag events.

From a market perspective, we believe the lack of resolution in Egypt will tend to prop up oil prices. Although we doubt the Suez Canal will be affected, worries about oil flows will add some risk premium to oil prices until the country stabilizes, especially Brent. Outside of oil, there are few immediate risks. Longer term, the lack of superpower direction is, in our opinion, the primary reason why the secular bear market in equities persists.

Bill O’Grady

August 26, 2013

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.

1New York Times, “Egypt Widens Crackdown and the Meaning of ‘Islamist’,” Aug. 24, 2013

2 The line, “He may be an S.O.B. but he is our S.O.B.” has been attributed to President Roosevelt (referring to the Nicaraguan dictator Somoza) or to other Secretaries of State when referring to other authoritarian strong men.

3 See Bremmer, Ian, “The J-Curve Effect,” Simon and Schuster, 2006.

4 Hamas is an offshoot of the MB.

© Confluence Investment Management

© Confluence Investment Management

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