Weekly Geopolitical Report By Bill O Grady August 20, 2012 The Muslim Brotherhood s Long Grind Over the past two weeks, there has been an upswing in violence in the Sinai Peninsula. Last week, Egyptian President Morsi announced the forced retirement of several military leaders, the same men who ran the government after the ouster of the former president, Hosni Mubarak. It isn t completely clear that the two incidents are related, although it does appear that Morsi used the unrest in the Sinai as a way to remove the remnant Mubarak cronies. In the aftermath of the removal of these senior military officers, speculation ran rampant. Some analysts believed that the ousters signaled that the Muslim Brotherhood (MB) and Morsi had seized civilian control of the Egyptian government. As we discussed in our June 25 th report (WGR, Counterrevolution in Egypt), the Supreme Council of the Armed Forces (SCAF) previously used the judiciary (which the military essentially controlled) to disband the newly elected parliament and weaken the powers of the president. Morsi s actions last week appear to have reversed the SCAF s program to weaken the civilian presidency. At the same time, other commentators noted that these senior officers not only accepted their retirements but were appointed to positions running military-controlled businesses. It is unlikely that these leaders would acquiesce to being forced into retirement unless they realized that there was power to back up the ouster. We tend to lean toward the second analysis. In our earlier report, we assumed that the MB and SCAF were working in concert to control Egypt. This most recent series of events, we believe, is simply another iteration of the military and the MB defining their roles in Egyptian society. In this report, we examine the recent violence in the Sinai Peninsula. From there, we will discuss the changes to the Egyptian government and analyze how this situation may be a step further in the MB s slow program to gain control of Egypt. As always, we will conclude with potential market ramifications. The Crisis in the Sinai After the 1973 Yom Kippur War, the Sinai Peninsula became a demilitarized zone. Israel gained control over the peninsula after the 1967 Six Day War; although Egypt did temporarily recover parts of the peninsula during the 1973 conflict, Israel had reclaimed it by the war s end. In the treaty after the 1973 war, Egypt regained sovereignty over the region. However, it was essentially demilitarized with the U.S. leading a peacekeeping force of about 1500 troops. The treaty effectively ended Israel s southern military threat and allowed Egypt to recover without worry of an invasion from Israel.
Weekly Geopolitical Report August 20, 2012 Page 2 After regaining control of the peninsula, the Mubarak regime appointed a series of military governors to administrate the region. For the most part, the treaty was a success; no military conflict has occurred since the war ended. However, the peninsula has become a hotbed for jihadists and Bedouin insurgents. The diminished military presence, a function of demilitarization, allows these insurgencies to flourish. They generally fund themselves by participating in smuggling activities supplying the Gaza Strip. Israel and Egypt control the borders of the Hamas-controlled enclave, but the latter has built sophisticated tunnels that bring goods to the Gaza Strip. The insurgents bring supplies from the Sinai Peninsula to Gaza via these tunnels for money. This insurgency has, on occasion, attacked tourist resorts that exist on the southern and northern beaches. The Mubarak government would engage in periodic counterinsurgency operations to retaliate. Unfortunately, the military governments failed to improve the economic or social lives of those living on the peninsula, creating a steady supply of new terrorists. As the Mubarak regime was failing, the insurgents grew bolder. There was a series of attacks on natural gas pipelines that supplied Israel for which the government failed to respond. The insurgency grew bolder in this apparent power vacuum. The Attacks in August On August 5 th, insurgents attacked five Egyptian military checkpoints in the northern Sinai Peninsula. Egypt reported that 16 soldiers were killed as the servicemen prepared to break their Ramadan fast. The insurgent operations on August 5 th were unusually sophisticated. The Egyptian soldiers were completely surprised. Overwhelming trained soldiers so completely is usually not the work of minimally trained terrorists. After taking control of the checkpoint, the insurgents took two armored personnel carriers and tried to break into Israel. One was stopped at the border while the other was able to travel a few miles into Israel before being stopped by an Israeli helicopter gunship. The sophisticated nature of these attacks and the fact that Israel was able to respond much faster than Egypt have raised speculation that these attacks were a false flag operation. Such events occur when a friendly power attacks either itself or an ally but makes it look as if an enemy was the culprit. False flag operations are used to improve the bargaining position of the attacked party or to precipitate a war. History is dotted with controversies over such operations. For example, historians still debate the sinking of the USS Maine, which precipitated the Spanish-American War. At the time, the American media blamed the Spanish for the sinking and demanded retaliation. However, some historians have speculated it was caused by a boiler fire or by independence-seeking Cubans who wanted to encourage the U.S. to remove the Spaniards. Additionally, some have speculated that Franklin Roosevelt suppressed information about the Japanese surprise attack on Pearl Harbor to give him an event that would silence isolationists. In the Arab press, there was speculation that the U.S. or Israel was behind the 9/11 events to allow the Bush administration to attack the Middle East. For the most part, false flag operations are rare; what sometimes appears as a false flag is, in reality, an unexpected tragedy that leads to geopolitical reactions.
Weekly Geopolitical Report August 20, 2012 Page 3 The problem with the false flag argument is the qui bono issue; who benefits? Israel clearly does not (although the Arab media has blamed it for the operation); attacks like these give Egypt an excuse to build up their military presence in the Sinai (which has occurred). Hamas doesn t benefit either; an attack of this magnitude invariably leads to tighter border controls which isolates the Gaza Strip (which has also occurred). Although a true Machiavellian might argue that the MB might be behind the attacks, in order to discredit the military and weaken their grip on power (which has occurred), it is doubtful that the MB would be willing to murder its own soldiers for this aim. Secrets are hard to keep and if evidence ever emerged that the Brotherhood was part of such a traitorous act they would likely face enormous repression. There are two likely culprits, al Qaeda and Iran. The former is capable of sophisticated attacks, and there have been rumors that the group has been taking advantage of the relative lawlessness of the Sinai to boost their presence. Iran has a well developed covert force and is a candidate for this operation as well. Since 9/11, al Qaeda has tended to claim responsibility for its attacks to prove it is still a force to be reckoned with. The lack of anyone taking credit suggests that al Qaeda wasn t behind these events. Overall, Iran could have led this operation. It would likely solidify the MB government in Egypt, which is more sympathetic to Iran compared to the secular-military establishment. In addition, if Iran can force Israel to increase its defense posture in the south, it reduces Israel s ability to attack Hezbollah on the country s northern border. When Iran engages in covert attacks, it almost never takes responsibility; it either keeps quiet or leaks media reports stating some previously unknown terrorist group was to blame. Egypt seems to be placing the blame on Hamas. It has closed the border with the Gaza Strip and limited smuggling through the tunnels. Hamas is going out of its way to show it was not behind the attacks, to no avail. It isn t likely Hamas was behind the attacks; they had nothing to gain. Taking Advantage of a Tragedy Assuming the MB was not responsible for the attacks, it clearly used the event to its advantage. The SCAF and the MB have been engaged in a quiet battle for domination. As noted earlier, before Morsi took office, the military, by virtue of a judicial decision, nullified parliamentary elections and severely restricted the president s powers. Morsi has been working quietly to restore these powers and, until recently, was taking criticism for not being more confrontational. However, almost immediately after the attack, the governor of the Sinai and the head of intelligence were replaced. Morsi cited the failure of security to protect the soldiers as reason for the dismissals. On August 11 th, Morsi made additional changes, announcing the retirements of Field Marshall Tantawi, the defense minister, and Lt. Gen. Sami Hafez Anan, who was chief of staff and seen as a potential successor to Tantawi. Tantawi was acting head of state after Mubarak fell from power. In addition, the heads of the major service branches were also replaced. Morsi also revoked the judicial orders which invalidated the parliament and reduced his power. Egypt and the world watched to see if the military would accept these changes. It has become clear it would. It appears that Morsi cut a deal with younger military officers; the
Weekly Geopolitical Report August 20, 2012 Page 4 younger officers were promoted into positions of power in return for supporting Morsi. The older generals had no choice but to accept this quiet coup within the military. However, it should be noted that the retiring generals have not been arrested. Instead, they have all taken positions within the military-managed industries of the economy. The military controls major parts of the Egyptian economy. These appointments indicate that this pattern of military control will continue. The generals also received high honors for their service to Egypt. What Does This Mean? Morsi has gained some leverage over the military. The younger generals were able to move up because Morsi took advantage of the military leadership s embarrassment over the Sinai attacks to force the old guard s removal. At the same time, Morsi did not undermine the military. The retiring generals were able to leave with dignity and a job. Even more critical was the continued military involvement in the economy. The recent events in Egypt are part of a grinding war of position between the SCAF and the MB. The latter gained position in this most recent situation but it has not scored a decisive win against the military. The MB was repressed for decades; this means that the Brotherhood tends to move cautiously to make and solidify gains. It knows from experience that moving too fast prompts countermeasures that can set the movement back. The real losers in this battle are the secular civilian parties, many of whom were seen during the Arab Spring demonstrations, the Christians and the hard-line Salafists. Egypt is not evolving into a Western Style democracy. Instead, a duopoly of power is emerging between the SCAF and the MB. We expect these two groups to share power and work slowly to define each other s role. For the most part, we believe the SCAF does not want to govern. The military wants its prerogatives protected and its veto over major policy changes in place. However, it would prefer the work of daily governing to be in the hands of civilians. It is quite possible that the younger officers, who are now in positions of power, are more comfortable with civilian rule and the role of religion in society. The Mubarak generation feared Islamists after the assassination of Anwar Sadat. That isn t going to be as big of an event in the minds of the new generation of military leaders. The biggest geopolitical issue surrounding the recent events in Egypt is that it will raise fears in Israel that it can no longer trust that its southern border is safe. The major benefit Israel received from the peace treaty with Egypt was the demilitarization of the Sinai. If that situation changes, Israel will be forced to defend its southern border which will weaken its ability to project power elsewhere. Egypt, with Israel s approval, has increased its military presence in the Sinai. In fact, a recent helicopter gunship attack on insurgents by the Egyptian military was the first air strike on the peninsula since 1973. Although Israel realizes it must allow Egypt to increase its military presence in the region to reduce the insurgent threat, it raises the fear that this increase in power may be pointed at Israel s border at some point. Overall, it is this change that increases the likelihood that Iran was behind this insurgency. Reducing Israel s ability to project power toward Lebanon and Syria, and much less toward Iran, is a desirable goal for the mullahs.
Weekly Geopolitical Report August 20, 2012 Page 5 Ramifications In general, the market ramification of any event in the Middle East is that it supports oil prices. Recent aggressive rhetoric from Israel against Iran is, in part, due to increasing fear among the Israeli leadership that conditions in the region are changing rapidly, and Israel is becoming vulnerable to these changes. Overall, we expect Egypt to remain peaceful. The MB in Egypt, though capable of radical thought and behavior, has been conditioned to be very careful in how it attains and manages power. We would not expect them to do anything rash. Even though recent events led to some commentators making breathless statements suggesting radical change and democratization was coming, we believe the MB and the military have been working in concert to adjust to the new reality. This duopoly of power should remain in place for the time being as the SCAF and the MB establish their roles in Egyptian society. Change will occur, but it will be a slow evolution, not a revolution. Bill O Grady August 20, 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. Confluence Investment Management LLC e Confluence Investment Management LLC is an independent, SEC Registered Investment Advisor located in St. Louis, Missouri. The firm provides professional portfolio management and advisory services to institutional and individual clients. Confluence s investment philosophy is based upon independent, fundamental research that integrates the firm s evaluation of market cycles, macroeconomics and geopolitical analysis with a value-driven, fundamental company-specific approach. The firm s portfolio management philosophy begins by assessing risk, and follows through by positioning client portfolios to achieve stated income and growth objectives. The Confluence team is comprised of experienced investment professionals who are dedicated to an exceptional level of client service and communication.