by Bill O’Grady

(Next week, we will publish our 2017 Geopolitical Outlook; it will be the last issue of 2016.)

In Part 1 of this report, we discussed the geography of the Philippines and examined the nation’s history, focusing on its relations with the U.S.  In Part 2 of this report, we will discuss President Rodrigo Duterte’s recent foreign policy decisions and their impact on U.S. policy in the region.  We will conclude with the impact on financial markets.

President Duterte

The 2014 Enhanced Defense Cooperation Agreement (EDCA) led to a significant shift in U.S./Philippine relations.  As the maps in Part 1 showed, the Philippines are key to controlling the sea lanes in the region.  If the Philippines were to become hostile to American interests, allies such as Japan, Taiwan and South Korea would be vulnerable to supply interdiction as the sea lanes would no longer be secure.

While the EDCA improved the security posture of the U.S. in the Far East, the Permanent Court of Arbitration’s ruling in July against China was a huge moral victory.  The international tribunal at The Hague offered a sweeping rebuke of China’s behavior in the South China Sea, completely rejecting China’s “nine-dash line” claims.  The Xi regime is furious over the outcome and has decided to simply ignore it.  Like most international agreements, there is no enforcement mechanism other than global reputation.  However, reputation does have some currency and it isn’t out of the question that the U.S. could decide to enforce the rule.  The U.S. Navy is powerful enough to dislodge Chinese forces off the rocks in the South China Sea, although it would likely trigger a wider war.  Still, at a minimum, the EDCA and the verdict at The Hague have given the Philippines leverage when negotiating with China.

However, the new Philippine president has jettisoned any advantage he gained from the court’s ruling by deciding not to press the issue with China.  Instead, Duterte met with Chinese officials and essentially told them he would not dispute Chinese sovereignty.  This decision followed a series of comments from Duterte which signal a rupture of relations with the U.S. and a turn toward China.

In October, Duterte indicated that he is “separating” with the U.S., claiming that “America has lost now.”  He also intimated that he would consider allying with Russia and China.[1]  Later in the month, he indicated that he wants U.S. troops out of the Philippines “in the next two years.”[2]    Although the U.S. continues to hold joint patrols, Duterte has indicated that he wants those to end as well, ostensibly because China doesn’t like them.[3]  Obama administration officials note that there have been no official requests to end these arrangements, but the tone has clearly been set.

It would be a major win for China if Duterte is able to follow through on this shift.  Not only would it have a clear exit from the first island chain (see map below), but China would have effectively divided that chain and put U.S. allies at risk.  In fact, American geopolitical objectives in the Far East are arguably in danger of being undermined.

View the full report

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[1] http://www.cnn.com/2016/10/20/asia/china-philippines-duterte-visit/

[2]https://www.washingtonpost.com/world/philippines-duterte-now-wants-us-troops-out-in-two-years/2016/10/26/32bec8a5-8584-4d95-8e9d-4d7762865055_story.html

[3] http://www.wsj.com/articles/philippines-leader-to-end-joint-military-exercises-joint-naval-patrols-with-u-s-1475086567