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Spies Like Us
Ursula von der Leyen, the European Commission president, once led a mysterious life. Owing to death threats by the Red Army Faction against her father Ernst Albrecht, a prominent Christian Democrat, and suspicions that she might be kidnapped, she was sent to study in London, under the alias ‘Rose Ladson’. As such, von der Leyen is unfortunately acquainted with the types of security threats that are live across Europe.
In her State of the Union speech last Wednesday, geopolitics and security had top billing. In particular, Russia’s hybrid war in Europe (from sabotage to manipulation of elections, as we highlighted in a recent note, Russia Risks Rising) is enunciated as the main risk, and institutionalized measures are being put in place to counteract this. A full European Security Strategy will be unveiled this autumn, part of which is a NATO style Article 4 measure, where one European nation (likely including Norway, the UK and Canada) can draw upon the support of others. Indeed, the sense is of a Europe broadly preparing to assume the structures and processes of NATO, in the event that the US disengages from it.
It is likely that a component part of the new European Security Strategy will be a European Security Council, whose role may be to run crisis management, cross country procurement and to liaise with close EU partners such as the UK and Canada. In keeping with Jean Monnet’s dictum that Europe only moves forward in a crisis, it has required a war in Ukraine, conflagration across the Middle East, not to mention a very unexpected shift in foreign policy by the White House, to get Europe to this point. Given that its EU level diplomatic service has effectively failed, partly because of national level competences and rivalries, the EC needs to take care that the same does not happen in the realm of security.
One concern, that is so far registering behind the scenes, is a growing rivalry and even antagonism between the French and Germans in the areas of innovation, battle readiness and funding. Another more profound concern is that different EU countries have very disparate levels of competence when it comes to intelligence gathering and operations.
European nation states have been spying professionally for centuries, and Christopher Andrew’s excellent book ‘The Secret World’ makes this very clear. Some have allowed these skills to wither, and others have had to pivot to meet new challenges. Spain’s intelligence effort was almost entirely focused on domestic threats (separatists) up until the lethal Madrid bombings in March 2004, and thereafter it had to quickly build up an external facing capability. Other nations, from Sweden to Japan, are now augmenting their external-facing intelligence services.
In this context, the French magazine L’Express has, based on interviews with sixty former spies (including some agency chiefs), scored and ranked Europe’s intelligence agencies, and there is a very good discussion of the process in the Collimateur podcast. The runaway winner is MI6, on 261 points, followed by France’s DGSE on 169 points (judges apparently gave them high marks for their field operations), followed by the Netherlands on 97 points (renowned for their discretion and cyber capabilities). Then, maybe unsurprisingly in fourth is Ukraine’s secret service, given the extent of the challenges it has faced. Germany comes some way behind in fifth, followed mostly by the Nordic countries, Poland and Estonia.
A number of large countries are well down the list, such as Spain and notably Italy (Estonia gets 27 points as compared to Italy’s 9 points), as are wealthier countries Switzerland and Belgium. Austria and Portugal prop up the end of the list, and the likes of Hungary and Slovakia get zero scores, and according to the authors of the research report, are largely untrusted. Ireland did not feature. There are broadly two axes of strength, London/Paris and Den Haag, and the other to the north (Nordics/Baltics down to Poland). The south of Europe is weak, as are a number of EU members to the east.
Today, the majority of the intelligence agencies in Europe are united by the challenge presented by Russia, not to mention hybrid actors (gangs and cyber-attack groups) as well as some powerful corporate intelligence teams. There remains insufficient trust between many of them, and the opportunity for hostile actors to target weaker states is significant. Lurking behind the ranking is an ongoing reliance on US intelligence.
By that mark, Europe’s spies have a long way to go.
Have a great week ahead, Mike
The Rotten Heart of Europe
One of the first books I read that helped to explain how Brussels worked was Bernard Connolly’s ‘The Rotten Heart of Europe’, published in 1995. It was a massive hit (in the UK) and hugely controversial. Indeed, a second edition came with a cover recommendation from the then editor of the Spectator Boris Johnson (‘one wanted to stand on the desk and cheer’).
The book did much to propagate Euroscepticism in British politics, and we might trace some of the roots of Brexit to it. With some irony, Brexit showed that the Commission can function in a forceful way when a crisis befalls it. However, as is well documented the challenge for the EC is to now step up a level and reinforce itself for a multipolar world where it will compete more acutely with China and the US, with at the same time Russia snapping at its heels.
Connolly’s book came to mind a week ago when speaking at an investment conference. I was joined on a panel by economists and policy makers from Italy, Spain and Portugal, so that together we made up a representative group of the euro-zone periphery countries hit hardest (though Greece suffered the most) by the euro-zone debt crisis.
Each of the periphery economies has had a remarkable turnaround – Italy is a bastion of political stability, Spain is the fastest growing of the large economies and Greece, Portugal and Ireland are arguably ‘too hot’ in terms of the rate of growth and price inflation they experience. What is telling is the signal from bond markets – yields for Italy, Spain and Greece for example, are below those of France and the UK, and Ireland is nearly on a par with Germany.
In that respect, the tables have been turned. It is not forgotten how Angela Merkel and Nicola Sarkozy upbraided the lazy Mediterraneans in the 2010’s. Now, the three large countries at the heart of European history – the UK, France and Germany, are struggling, and to unkindly borrow Bernard Connolly’s title, constitute the ‘rotten heart of Europe’
They share common problems – sluggish, low growth, an inability to foster sustained private investment, political instability in the face of electorates who are in thrall to the easy solutions of populist parties. The reaction to last week’s triumph of the AfD (Alternative fur Deutschland) in Saxony-Anhalt is an example, and it may mean that Frederich Merz suffers the fate of Keir Starmer should his coalition collapse or his party cast him aside in favour of a younger leader.
Though the tempo of growth is picking up in Germany, the UK and France, it will not rescue the leaders of the large economies. An additional complexity is that trading partners and allies are turning against them – China is exporting its manufacturing over-capacity to the German consumer and the special relationship that characterized US-UK diplomacy has all but withered away. The prospect that the White House might favour Argentina’s case for sovereignty over the Falkland Islands is a stunning case in point.
Unlike France, the British and German economies suffer from a similar failure to upgrade their ‘production capital’ – investment in research, skills, new technologies and to an extent, manufacturing capacity. Both are behind France in terms of military power, but France is a leader in over-regulation. The fate of these three great nations has already inspired an endless flow of analyses, ideas and suggestions – the best of which from Mario Draghi, seems to be ignored.
The sole thought I have to add, is that incumbent, centrist politicians in all three countries appear to ignore the increasingly obvious lesson that the rules of the geopolitical game have changed, and as we have referenced before in this note, we live in an ‘age of predators’, and consequently prey (Starmer). In this regard, new ideas are not the solution, but a change of method is. That method is more singular, less consensus led and aggressive. Edouard Philippe in France and Andy Burnham are its test cases, we will know by next May if they learn this lesson, and if not, Europe is in dire straits.
Have a great week ahead, Mike
Debt Purgatory
Roland Garros is one of the more stylish and elegant parts of Paris, and not a bad location to discuss finance and economics. Unfortunately, France’s political elite did not rise to the occasion. At the end of last week, (MEDEF), the large French business network gathered the principal candidates for the 2027 presidential campaign to listen to their views on the economy, and in particular their policies to pare back France’s gargantuan fiscal deficit and debt load. With a few exceptions, they disappointed.
The candidates for the far-left (Jean-Luc Melenchon of La France Insoumise) and far-right, Marine Le Pen of the Rassemblement Nationale, appeared to treat the event as a light-hearted post-holiday chat show, and not a forum to debate the faultline that could pitch the euro-zone into another debt crisis.
Though France’s presidential election is far off (the first round is on 18 April 2027), international investors need to pay close attention to it, both as a specific risk factor for bonds, foreign exchange and equities, and as a harbinger of what might befall most of the other major economies.
In this respect, France has at least two things in common with the US. First, its weak finances. The budget deficit has been stuck at 5%, a level historically associated with a recession, and debt to GDP is on course to hit 120% according to the OECD. Second, there is no appetite to tackle this dire fiscal situation. In the US, there is little prospect of corrective tax hikes or spending cuts, and the Trump administration appears to have a fetish for intervening in markets.
In France, three governments have been consumed by the process of setting a budget, and there is no political nor popular will to set France’s finances on a sustainable track. What is worse is that wild, populist suggestions that France could cancel the debt that the Banque de France holds (as a result of quantitative easing) are being aired in the media. France’s political class and populace are not known for their financial literacy, and the belief in some quarters that debt can be magicked away is dangerous and sets the economy up for a sharp reality check.
Having witnessed the brutal effect of a debt crisis and the subsequent austerity on the Irish economy from 2010 onwards, French policymakers and its public are badly unprepared for what may come. Government spending at 57% of GDP is comparatively huge, and much of this goes on social welfare (healthcare and pensions).
Unlike the US, France is not enjoying an AI capital expenditure fuelled wealth effect, and the notion that it might act to structurally boost economic growth is anathema to nearly all of its politicians. In a demonstration of moral hazard, France has accumulated debt at a pace and amount more than any other euro-zone country, without much protest from the ECB.
Markets however, are reacting. French ten-year bond yields have just passed Italy’s. While long-bond yields in Japan, the US and UK have all broken higher to multi-decade highs, the re-rating of France is troubling. For international investors, France’s changing status, from a core, safe haven, to a periphery market is one of several signals of a coming debt purgatory – a long period where indebtedness dominates markets, government politics and geopolitics.
For European policy makers, the fact that France is the indispensable nation on geopolitics, defence and military innovation complicates matters because it means that politically, in the context of German underperformance, France is harder to corral into a fiscal straightjacket in the same way the European Commission did with Greece, Ireland and Spain. On the European political stage, there is no-one fiscally credible politician who might stand up to France and avert the potential for contagion across the euro-zone.
If for instance, both Melenchon and Le Pen make it through to the second round of the presidential election, bond investors will desert France, French bank share will collapse, luxury goods firms will become bargains, and the euro will likely fall. Bond investors will likely rush to the few safe havens the euro-zone offers – Germany, the Netherlands and Ireland as well as assets in ‘old’ periphery countries like Norway and Switzerland.
More broadly, a continued rise in French yields, in the face of policy inaction (a draft budget is to be presented to parliament at the end of September), will for the first time in over a decade sensitize international investors to the credit risk inherent in government balance sheets. What is intimidating is that here France is in good company, most of the major economies, China, Japan, the UK and the US are as indebted as it is.
Everything is Fine
On September 16, 1992, the British pound was ejected from the rigid European Exchange Rate Mechanism (ERM) system that it had joined in 1990. In the ERM, the pound was linked to the Deutsche Mark but effectively at too high a valuation, making it uncompetitive. A few days later, Chancellor Norman Lamont tried to sound upbeat, telling journalists that ‘My wife said she had never heard me sing in my bath before,”, suggesting that he was happy to be rid of the ERM. This characteristic gaffe by Lamont was badly received at a time when British industry and households faced a sharp rise in interest rates.
The pound’s exit from the ERM came after painful interest rate hikes (from 10% to 15% in one day) and massive intervention from the Bank of England on one side of the foreign exchange market. On the other side, famously, was the speculator George Soros, who ‘broke the pound’ by selling billions of pounds in the expectation of a devaluation. At the time, a youngish Scott Bessent worked in Soros’ Quantum Fund. Today, as US Treasury Secretary, Bessent is having his ‘singing in the bath moment’.
Bessent has made two interventions in markets in the past month. The first, a historic joint move (the last one was in 1998) with the Japanese authorities to boost the yen. The involvement of the Treasury ensured that Japan was able to buy yen without selling Treasuries, which would have pushed US yields up. In that context, Bessent’s second intervention was a promise to effectively sell short duration bonds, and with the proceeds buy long duration ones, the intention being to push down long-term yields.
Bessent’s moves were greeted with puzzlement and some disdain in markets. Interventions in markets are rare, normally occuring when something is broken or about to break. When they do occur, they need to be large (almost unlimited) to have credibility. Mario Draghi’s announcement that the ECB ‘would do what it takes…and believe me it will be enough’ is the best example. Thus, the Treasury Secretary’s interventions give the impression that something is not quite right, and in this regard, at least three problematic issues are raised.
The first is that Bessent has announced the arrival of a debt crisis, or rather a debt purgatory, a long period where indebtedness weighs on government policy, markets, and geopolitics. The bond market intervention coincided with America’s debt burden topping the USD 40 trillion mark, and the Treasury Secretary has simply succeeded in drawing greater attention to this.
Markets registered this in May when long dated (30-year) bond yields on US, UK and Japanese debt hit levels not seen since before the global financial crisis. Bessent’s intervention shows that governments are now feeling the financial pain associated with this rise in yields and are starting to worry about how to curb it. A particular problem for the US, is that a mixture of geopolitics and AI driven debt issuance, mean that there are fewer natural or passive buyers of its debt.
The second element of note in Bessent’s actions is that they betray a philosophy across the Trump administration that is intensely focused on asset prices to the detriment of economic policy. The president’s active stock trading and public promotion of stock trades, billion-dollar forays into cryptocurrencies, and attempts to shepherd the oil price through social media are all part of this. At the same time, the US has a historically enormous budget deficit, which the rating agency Fitch expects to surpass 7%. In the past a deficit of such magnitude would only occur during a deep recession or financial crisis.
Today, in the context of a record high stock market, and an AI boom, it is a dangerous anomaly. Should something go wrong to pitch the US into a recession, there is no fiscal cushion. Bessent has done nothing to reduce the deficit and his tinkering in the bond market shows that the deficit is not his priority.
Thirdly, the bond market intervention is ill timed because the other ‘wing’ of American financial policy, the Federal Reserve, has a new chief, Kevin Warsh, also a former hedge fund manager. Warsh has a preference for a Fed that communicates less to markets, but he has so far not communicated well. Markets are unsure of his stance on inflation. The added complication is that Warsh prefers a more spartan Fed, one that is less active in bond markets, so the Treasury intervention is a contradiction of this. The other concern is that the Fed begins to suffer from fiscal dominance, which in simple terms means that in making policy, it is looking over its shoulder at the actions of the Treasury, and the sentiment in a wobbly bond market.
With markets still focused on AI, Bessent has unwittingly opened up a macro ‘battle’, which the bond market will surely win.
Have a great week ahead, Mike
Friends
An important sign that globalization is over and that America’s role as the keystone of the world order is crumbling is the flux in strategic alliances between countries, across multiple regions. Arguably there has not been a period of such furtive strategic alliance formation since before the Cold War. Globalization was a geopolitical anomaly in the sense that there were no major wars, international norms, rules of geopolitical behaviour and institutions were respected. This is certainly not the case today, and the idea of ‘fracturing’ we wrote about in 2020 is accelerating.
Sweden and Finland reacted to the invasion of Ukraine by joining NATO. Next week (29th) Iceland will vote to recommence membership negotiations with the EU and potentially join Moldova and Ukraine in the accession queue. Iceland had toyed with membership in the aftermath of the global financial crisis and the consensus in the small country is once again turning to Europe, because of ‘geopolitics’, by which Icelanders mean the presence of Russia in the Arctic and greater Nordic region, and American threats to ‘take’ Greeenland.
The Iran War will eventually provoke a re-alignment of alliances across the region, where the crucial variable is the relationship between the UAE and Saudi Arabia. Two weeks ago, Saudi Arabia, Pakistan and Turkey signed a joint defense pact in Mecca, an accord that has strategic implications for Iran, Israel and notably, India. During the period of globalization, Turkish foreign policy was conditioned by the maxim ‘no trouble with neighbours’. Now, Turkey is involved in some form, in every skirmish in the region – from Libya, to Syria, to Azerbaijan to Iraq.
Then in Asia, relatively new ‘clubs’ have been forming; AUKUS (effectively a US – Australia alliance), the Quad (Japan, the US, India and Australia) and the Shanghai Cooperation Organisation (China, Russia and Pakistan are the main members). For their part, South Korea, Japan and Taiwan, all formal allies of the US, will be worried by the gradual strategic distance that the White House is putting between its Asian allies, the most recent is the curtailing of joint military training exercises between American and South Korean forces.
Most of these alliances are motivated by a common factor; an America that is more singular, and less willing to be the world’s policeman. This change is complicated by the fact that the White House appears to have a fascination for autocrats (for example, Steve Witkoff, President Trump’s peace emissary has not visited Ukraine, but is a frequent visitor to Moscow). Indeed, some of the critics of the White House’s foreign policy stance, such as Harvard academic Stephen Walt, go a step further and have referred to the US as a ‘predatory hegemon’.
The net effect is that many countries will now experience the loss of the ‘policeman premium’ they enjoyed when America underwrote their defence, and instead will have to pay a ‘predator premium’; the higher security and defence costs associated with a more adversarial geopolitical climate. Germany is the case in point, where military spending and combat readiness had dwindled during the period of globalizations, but where it has now lifted its debt brake and will spend up to Eur 1 trillion on defence in the coming ten years. Corporates are also facing this defence friction – either through supply chain disruption, cyber-attacks or the theft of corporate secrets to the extent that corporate intelligence is a fast-growing field (Lewis Sage-Passant’s book ‘Beyond States and Spies’ is a very good text here).
The kaleidoscopic shift in alliances will likely continue, and a cautionary tale is the manner in which the tangled web of alliances that sprung up during the first wave of globalization (1870-1913) tripped itself up. Then Europe was split between the Triple Alliance (Germany, Italy and Austria/Hungary) and the Triple Entente (Britain, France and Russia). Margaret MacMillan’s books on the First World War (for example ‘The War That Ended Peace’) are worth a read and the parallel in the arms race between Britain and Germany then, and China and the US now, is striking.
Alarmists might worry that a ‘great power’ war is close, but the only saving grace from the wars in Iran and Ukraine, is that the great military powers struggle to achieve their aims in the face of new technologies and tactics. Let’s hope they learn these lessons.
Have a great week ahead, Mike
Bezzle Bonds
In my summer reading note (‘A Good Read’) an important omission was a couple of books by the celebrated economist JK Galbraith, the ‘Affluent Society’ which is relevant to the many economies struggling with low growth (e.g. UK, Germany), and ‘The Great Crash’, a text that will surely come in handy in the next twelve months.
In this book, Galbraith introduces the term ‘bezzle’ by which he means the rise in fraudulent financial activity as an investment bubble gathers momentum. A slightly different version of this is the rise of what we might call ‘non-traditional’ or opaque forms of financing as the asset bubble gathers pace.
One nuance of the bezzle, is that there is a moment of suspended financial animation, where the investor in the ‘bezzle’ feels rich, thinks he/she is a financial genius and at the same time the bezzle premium starts to accrue to the architect of the ’bezzle’. Falling economic activity and asset prices bring home the truth of the ‘bezzle’ to the investor.
Last week’s note on the intense financialization of the South Korean stock market gave a taste of the giddiness that is building around the AI capital expenditure boom. In this context, investment products, such as leveraged exchange traded funds and ‘single-deal’ special purpose investment vehicles in IPOs like SpaceX are ‘bezzle-like’, and it might be argued that new AI startups that raise capital at a high valuation are also bezzles, if not simply hubristic.
Now, activity in the bond markets and private lending segment is beginning to acquire a ‘bezzle’ premium. For example, last week six of the largest banks and private equity houses announced the creation of a USD 500bn ‘pool of capital’ for Nvidia, to facilitate the buildout of its AI infrastructure. The details of the deal are complex to say the least. This financing package will be considered ‘off balance sheet’, so it won’t immediately show up in Nvidia’s balance sheet, but it will bind the financial and AI industries more closely together (note that a chapter in the Galbraith book has the ironic title ‘In Goldman, Sachs we trust’).
What is interesting is that bond markets are starting to react. Bonds issued by the large AI firms, or ‘hyperscalers’, are beginning to trade at a higher yield, reflecting the market view that they are increasingly risky. For instance, spreads on the index of hyperscaler bonds are now nearly double what they were at the start of the year, and it is much the same for credit default swaps.
This is important in at least two respects. First, it signals that individually some of the hyperscalers (META and Oracle are often mentioned) are running down their cashflow rapidly and building up debt just as quickly. Second, the corporate sector is becoming indebted again (from modest levels), under the spell of AI infrastructure build.
This is concerning as we look towards 2028 (when in my view the AI capital expenditure boom judders to a halt) because public debt levels are already considerable, in fact they have never been higher across the major economies. To that end, public debt markets are also beginning to price in a riskier outlook (long dated bond yields in the UK, South Korea, Japan and the US are at or close to multi-decade highs). Rising real yields (inflation adjusted) tend to be a more cautious signal for markets. Equity markets appear not to notice, or care, but other asset classes like foreign exchange are also signalling trouble in the engine room (the joint US-Japanese intervention in the yen was a case in point).
The net economic effect is a sort of balance sheet ‘bezzle’, to stretch the analogy. In the US, households have never been more exposed to the equity market, and its rise is producing a marked wealth effect. Based on long run valuations, this wealth effect may be close to peaking though the psychic wealth effect remains strong. On the other side of the balance sheet, government debt continues to grow – one third of all the debt that has been issued by the US has come during the Trump administrations, and corporate debt is edging up as AI infrastructure spending gathers steam.
Have a great week ahead, Mike
KOSPI Chaos
Apocalyptic stories are emerging of how retail investors in South Korea have made, and then quickly destroyed fortunes in the country’s stock market boom and bust and, we may soon learn that institutional investors, trading firms and banks have been damaged by the fallout. Korea’s Kospi index, which more than doubled from the end of 2025 to its mid-June peak, has collapsed by over 40% since then, with a one-day bounce of 18% at the end of last week.
The index has become an economic absurdity and its volatility (VKOSPI index) is greater than during any of the financial and economic crises of the past thirty years, the Asian crisis of the late 1990s included. There will be considerable damage to the South Korean economy, but so far, unlike the Asian crisis, there is relatively modest contagion across other markets (despite South Korea having rocketed into the top six equity markets in the world).
The absence of broad contagion is not an ‘all clear’ signal. Rather, South Korea is the latest, lurid event in an epidemic of speculation across the world, that is built on the financialization of real economy companies, assets and technologies. While South Korea’s largest technology firms, Samsung and SK Hynix, have become key elements in the AI supply chain thematic (specifically for computer memory), their performance has been wildly exaggerated by financial engineering.
Brokers have created leveraged single stock exchange traded funds on these firms and others, and in recent weeks, trading volume in these financial products has outstripped volume in the underlying stocks by a factor of four times. Option trading volume in Korea has exploded, as has the creation of warrants and structured products, again based largely on the memory stocks. Now, some 3x leveraged Exchange Traded Funds (ETFs) are down between 80 to 95% from their recent peaks. Of course, the majority of trading activity has come from retail investors in Korea, many of whom have used margin debt.
This might all be a bit of emerging market fun were it not for the fact that South Korea is emblematic of the global investment ecosystem, which is driven by the logic of AI capital expenditure but built on the increasingly wobbly foundation of financial engineering. As an illustration, LongView Economics, the independent strategy house, has constructed a ‘Speculative Fervour Index’, based on leveraged ETF activity, and it has risen sharply in the past year, coinciding with an all-time high in US household ownership of equities.
From that vantage point there are at least three serious policy concerns for the US and for American retail investors, if they choose to listen.
The first is a repeated transfer of risk from institutions to retail investors. Semiconductors was just the latest episode, following the SpaceX IPO and the rise and fall of silver and gold earlier this year. The day retail investors stop believing they can beat the market, they will be furious. US households have never owned more equities, wealth per adult has never been as high in America, and wealth inequality in the US is straining historical comparisons. Repeated shocks to households will soon have economic and political effects.
The second effect is the relation between investment and the economy. In an era where Carlota Perez’s (author of ‘Technological Revolutions and Financial Capital’) concept of ‘production capital’ is gaining traction, and where the rebuilding of industrial capacity in the US and EU is a necessity, the risk is that financially engineered investment instruments squander capital and misdirect it from economically meaningful investment projects. High stock market valuations may convince politicians that everyone is getting rich, but there is a serial misallocation of capital occurring before them.
This leads to my third point, which is the role of policy makers, central bankers and regulators. It used to be the case that market stability was a concern for regulators and central bankers, the South Korean authorities have been late to the scene of the fire. In the increasingly ‘regulation-lite’ environment of Wall St., the dominance of financial engineering (there are more ETFs than stocks now and option trading volumes continue to surge), the risk of sporadic volatility events, and, at some stage, a much greater unwind. It should also be a concern for Kevin Warsh, and this is just one topic he needs to be more forthright on.
For their part, US investors have carried on where the Koreans have left off. In the past three trading sessions, options trading volumes have spiked, driving equities higher. A volatility ‘event’ may not be far off.
Have a great week ahead, Mike
A Good Read
An emerging trend in our screen driven societies is that fewer people are reading books. A YouGov poll found that 40% of Americans did not read a book in 2025, though nearly all of them consumed streaming services and social media. Other studies, from the National Endowment for the Arts and Bureau of Labor Statistics highlight that younger generations read less, and a number of studies (such as the Programme for International Student Assessment (PISA) attainment scores) show that reading proficiency in many high-income countries is declining. Worse still, AI is taking over writing, to the extent that the FT ran a headline last week ‘The new premium product: books written by people’
A counterargument is that people are consuming fiction and non-fiction in different forms (such as audio books) but, in my view, it’s just not the same. Reading involves consuming ideas with the ‘brain-on’, and by not reading we miss out, not only on great tales, but the lessons of history, human behaviour and the world we live in.
However, I know that most of my readers love books, and as I head off on holiday, I want to recommend a few titles. I divided these into two categories, the books I ought to have read (non-fiction), and the books I really wanted to read (fiction). In that spirit, I packed my bag with a couple of serious books, but once I settled into the hotel, I found a cheap thriller written in 2006 that I read instead.
Starting with the serious books, I packed ‘Twilight of the Dons’ by Colin Kidd, not a text that will grace many beaches I imagine. The book recounts a period when academics had a much more vaunted position in British public life (it was said that the motorway from London to Oxford was built so that ministers could leave Westminster in the evening to dine at All Soul’s College).
The book bolsters the view that one of the reasons for the crisis that Britain finds itself in is the desiccation of education and learning, in terms of the devaluation of the idea of education as a public good, diminished funding from the state and the strange preference for overseas students over British ones in the best schools and universities. I had a vague hope that Andy Burnham, the first Cambridge educated prime minister (a student of Literature) might encourage a more learned approach to government, even if his first week in office leaves me lukewarm.
Then, the book I am really looking forward to reading is ‘1873’, by Liaquat Ahamed. His first book ‘Lords of Finance’ related the emergence of central banking in the US and Europe in the 1930’s and is one of the best economics books I have read, and a work that was clearly written with great passion.
‘1873’ relates the events around the market panic and financial crisis of 1873, a period of ‘true capitalism’ in the sense that then there were few of the policy guardrails we have today. Apart from Ahamed’s writing, the book is relevant today for its detail on the railway investment boom, and the subsequent deep recession that followed the Panic of 1873. In that context, there is an alarming rise in books whose titles recount financial collapse, another one is Andrew Ross Sorkin’s ‘1929’ which is rich in detail on the social and political context of the 1929 crash.
To finish my economics recommendations, another question that besets commentators and investors is the future of the dollar. In 1976, the economist Charles Kindleberger declared ‘The dollar is finished as an international money, but there is no clear successor’. This view is largely correct, but the prospect that America’s power is diminishing, may have consequences for the dollar, and there is a flurry of new books on the role of the dollar, of which books by Barry Eichengreen (Money beyond Borders), Ken Rogoff (Our Dollar, Your Problem) and Paul Blustein (King Dollar) are prominent.
One book I have mentioned in recent notes, and that I reiterate is Giuliano da Empoli’s ‘The Hour of the Predator’, which succeeds in capturing the spirit of our political times. We have moved from a period of democracy and technocratic engagement between nations, to a lawless one, dominated by autocrats and oligarchs, who vandalise laws, norms and institutions under the false premise of enacting change. The principal lesson today is that centrist politicians, Keir Starmer was the example, need to stop becoming ‘prey’ and change their tactics.
Then, more specifically on AI, last week I wrote on the speed at which the sector is evolving and find it hard to recommend books that can keep pace with this (the best source I have is Azeem Azhar’s Exponential World blog). So, I fall back on Carlota Perez’ framework in ‘Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages’. Another useful book in this context is Johan Norberg’s ‘Peak Human’ which describes the emergence of empires, their deployment of technology and sketches the lessons for our world.
Now, with the holidays really in mind, I jump to non-fiction. One of the best books I have enjoyed this year is Alex Starritt’s ‘Drayton and Mckenzie’ is an absorbing story of two entrepreneurs, written in a stylish, mischievous way that does an excellent job of capturing the prevailing economic trends of the past twenty years.
Also, some of my favourite writers have released new books in the past year – William Boyd’s second, amusing Gabriel Dax story ‘The Predicament’ (with ‘Cold Sunset’ out in September), and Ian McEwan’s ‘What We Can Know’. I’ve just read the first of John Banville’s ‘Quirke’ series (Christine Falls) and recommend it, together with the latest in the series ‘The Drowned’ and ‘The Lock Up’. If readers are looking for classics, I propose Bram Stoker’s ‘Dracula’ for a summertime scare.
In the realm of thrillers, an entertaining, new writer I have come across is David McCloskey, a former CIA analyst, co-presenter of the fun podcast ‘The Rest is Classified’, and already author of four espionage thrillers, the latest of which ‘The Persian’ I recommend.
I’ve just finished reading Nick Fox Weber’s book ‘The Art of Tennis’, which is remarkable for the quality of his writing and the breadth of his knowledge of sport, American society and art. It set my mind searching for comparable writers on sport, and the one who comes to mind is the late David Halberstam, I loved his book ‘The Amateurs’.
Enjoy, Mike
Cheap and Cheerful
Quite some time ago I attended a seminar by Carlota Perez, a British-based Venezuelan scholar whose work focuses on the ways in which technological innovations, finance and economics work together to produce great waves or periods of investment and periodically, prosperity. At the time, books like Thomas Kuhn’s ‘The Structure of Scientific Revolutions’ were fresh in my mind, as was the recent aftermath of the dot.com bubble.
Perez’ work (much of which is on her website) is best explained by the title of her well known book ‘Technological Revolutions and Financial Capital: the Dynamics of Bubbles and Golden Ages’, where she describes the phases that accompany technological innovations as they acquire investment and begin to ripple through economies, and change the structure of those economies. In common with scholars of developmental waves (for example she was awarded the Kondratiev Silver Medal in 2012) she maps how major technological revolutions (such as the 18th century Industrial Revolution, steam engines, railways, manufacturing in the form of automobiles and oil drilling for instance, and telecoms/internet) develop in phases.
The principal phases she outlines begin with the Installation phase, where capital rushes towards the new technology, fuelling the build of new infrastructure and new sub-industries and economic activity, but also driving asset bubbles which inevitably crash or hit a ‘turning point’ as she politely puts it. The next phase is ‘Deployment’ where the new technology is widely used, and public policy, regulation and society accommodate it. Investment-wise, the economic applications of the technology enter into the mainstream. Readers will quickly spot the relevance to the AI capital expenditure boom.
An interesting distinction Perez makes, which I think is highly relevant, is that between ‘financial capital’ by which we can understand fast moving speculative money, and ‘production capital’ which is devoted to building of specific technologies, skills and infrastructure and is by nature more ‘committed’. Nicolas Colin, a French economist has written a lot on the emergence of ‘production capital’ in his blog, Drift Signal. I am tempted to say that Europeans might hold that ‘financial capital’ is American and ‘production capital’ is European, but Europe has a deficit of both.
It seems to me that the difference between AI and the historic phases of technological innovation mentioned by Carlotta Perez, is speed. The speed with which models are improving, the speed with which capital is being deployed, the take-up by users, and the speed with which the winners and losers are emerging at the corporate level.
A couple of months ago, we wrote about the mixture of wonder and panic created by Anthropic’s Mythos model. Then, it was assumed that Chinese developers were some seven months behind the Americans, but last week, Moonshot, the Chinese AI developer released test results of its Kimi K3 model (conveniently, they are in the middle of a fundraise), which apparently match some of the capabilities of Mythos. There has not been much of a market reaction to this in the US but, the red-blooded capitalists of Silicon Valley and the AI industry are crying alarm, running for Washington and calling for the US government to ban Chinese models.
Their dismay, consistent with the Perez framework, portends a speedy evolution in the structure of the international market for AI tools. China’s models are much cheaper than those in the US, partly because they piggyback on work done by the Americans, partly because of cheaper energy in China, and partly because of fierce competition amongst Chinese developers (and the winners get a boost from the Chinese government). In the near future, those who want cheap, cheerful and clever AI tools may well gravitate to the Chinese AI products (as Germans are now doing with Chinese cars, see last week’s note, Is China OK?))
The American AI models will still be useful for a number of things. The first is that they will continue to lead frontier AI development, in analytical power, and increasingly on specialised datasets and applications. Secondly, they will be favoured by Western corporates, especially in closed systems, and thirdly, they will continue to have a strategic role – either in applications across nations (from security, warfare or healthcare for example) or as strategic exports (here I am thinking of G42, the UAE’s AI firm that has an exclusive relationship with US AI models).
To that end, capital will flow more to cutting edge AI, sovereign AI and secure corporate AI in the US, and very likely in Europe (Mistral, Europe’s last hope is currently raising capital at a measly Eur 20 bn valuation). In my view, we are still some way away from a ‘reckoning’ in AI stocks, and proof of the hubris in the market is that the large investment banks involved in the SpaceX IPO continue to issue research notes, with embarrassing justifications for their lofty price targets (Morgan Stanley thinks SpaceX, which trades at USD 135 is worth USD 300).
Still, markets are beginning to sniff the weaker players – Oracle, whose balance sheet is far weaker than rival hyperscalers, has seen its value halve in the past two months. Writer Sebastian Mallaby, amongst others has stated that there is a high risk that OpenAI might run out of money. For the time being, the show goes on.
Have a great week ahead, Mike
Is China OK?
For much of the last decade or so, Chinese friends and acquaintances, as well as many people I know in Singapore and Hong Kong, have remarked that their view of Europeans is a lazy and decadent people, too tolerant of the problems that beset their societies. This view is in part gentle mockery, and part sincere. Europeans, not used to being mocked, will look up from their Aperol spritz and ask what they are doing wrong?
Indeed, according to the latest (and fourth) University of Alberta ‘How China sees the World’ survey, it seems that most Chinese don’t rate the EU as a major geopolitical player, though a significant economic partner and more importantly, a tourism destination.
The survey highlights that the Chinese have a strong view of their country’s importance on the international stage, pitting it ahead of the USA in a bi-polar world order. The interesting elements in the survey are the casting of Russia as an indispensable, trusted partner on the international stage for China, and the confidence with which participants gauge a war with Japan as a likely geopolitical event.
To an extent, it is welcome to consider Chinese views on the rest of the world, granted the irony that for such an important economic and geopolitical player, there are relatively so few Western experts on China, and in Western public discourse there is not a well-developed conversation on Chinese culture and politics. Consider that there are very few Irish public figures who know China well, and the evolution of China’s economy does not get enough detailed attention in the Irish media, despite China’s enormous role in the world economy.
This might be because China makes it increasingly difficult for outsiders to understand it. In the past seven years, Western investment in China has dropped significantly, and the flow of Westerners to work in China has also fallen. A further illustration is that there are now fewer than 2000 Americans studying in China according to the Straits Times (down from 11,000 in 2019) while there are still some 250,000 Chinese studying in the US (down from 354,000 in 2019), and a further 150,000 Chinese studying in the UK (and close to 4,000 in Ireland).
The reduced social, political and commercial connection between China and the West makes it harder to read what is happening to the Chinese economy, with the additional concern that official Chinese data is not helpful either. Granted that China last week printed one of its lowest official GDP growth readings, this is a significant hurdle. Indeed, there is a sense amongst many Western economists that only an amalgam of very detailed, micro indicators (e.g. electricity usage) can help build a picture of what is really happening in the Chinese economy.
For example, In the USA, the Conference Board has reconstructed China’s economic data, and has concluded that not only has the performance of the Chinese economy overestimated, but it has been driven by the flow of huge amounts of capital into the economy that has steadily become less productive (in the sense that one dollar of capital leads to a decreasingly small return). It may be that the Conference Board team has gotten it wrong, but there is simply neither the forum nor the spirit for an open debate on Chinese data. Also, a prominent Chinese economist Gao Shanwen, who died of cancer last month, had stated publicly that the trend rate of growth in China is far lower than official figures suggest.
Despite that, the most interesting element is that the Chinese authorities have managed their economy better than most have thought, and to use a headline from the New York Times, China’s economy ‘has failed to fail’ in the sense that it has not had an obvious cyclical recession in decades.
If there is a strategy behind this, it looks from afar, as the state pushing activity from one economic engine to another. The Chinese property market has steadily deflated over the past six years, and the financial consequences of this have in my view not fully registered with banks and households. At the same time, through a mixture of state guidance and ruthless industrial competition, China has shifted the locus of activity to manufacturing (and the last Plenum, policy making forum, has ordained deep tech as the spearhead of the Chinese economic effort).
One consequence has been the creation of over-capacity, but in goods of sufficient quality and low production cost, that they displace European markets. Last week, exports of Chinese cars to Europe have just topped a monthly tally of 1 million, while European manufacturers (even Porsche) are struggling in China. The result is a crisis of confidence in German manufacturing, and a policy debate on how to curb the flow of Chinese exports into Europe.
In the past year, China has pursued an ‘involution’ policy, of reducing spare capacity across a range of industries, but this does not yet appear to have borne fruit and raises the risk that there is still a lot of operational leverage in the economy. Two other risks loom. One consequence of the funding of real estate and manufacturing through the banking sector is that in terms of assets, China’s banks are amongst the largest in the world, a systematic risk in the event of a downturn, and its public (including local and regional authority) debt, is dangerously high.
With trading partners, such as Germany, beginning to react to China’s export boom, the policy options for Beijing are increasingly limited as they try to maintain economic momentum. Another bad GDP print and investors will start to fear the worst.
Have a great week ahead, Mike
The Levelling 