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Two Jabs

I have thankfully gotten my ‘two jabs’ and theoretically at least should be free to roam the world. Before I do that, a quick detour to John Prescott, once the UK’s Deputy Prime Minister from 1997 to 2007, who being attacked (an egg was thrown) whilst on an election canvas, responded with his fists against his assailant. As a result he was nicknamed ‘Two Jabs Prescott’. Prescott came to mind when I read of the physical attack on French President Emmanuel Macron.

What was noteworthy was not the stupidity of the attacker but Macron’s response afterwards – he stated that his role was to get out and meet people, hear their concerns and rebuild trust with them. With that, he has put his finger on one of the essential political issues of our time – that people no longer trust their governments and the institutions that rule over them. In France there is speculation (misplaced I think) that Marine Le Pen will sweep to power, and in the UK and beyond a growing realization that Boris Johnson individually is untrustworthy.

More broadly, a few surveys sketch a worrying picture. The PEW Centre in the US shows that trust in government is very low – only 24% of Americans trust their government (the low point was 17% during the Trump administration), compared to 50% after 9/11 and 77% during the Kennedy era.

The OECD Trust in Government project shows a similar picture – globally only 45% of people trust their governments and have a much higher level of trust in education and healthcare systems (in the USA healthcare and military personnel are amongst the most trusted professions – with politicians, banker and journalists at the low end of the trust spectrum).

Across societies, an interesting picture emerges. The World Values Survey shows that in smaller advanced economies – the Nordics and Switzerland for instance – people have a high (60%) level of trust in each other (this may be due to country size, culture and proximity of populations), but in many emerging countries with weak institutions and rule of law (i.e Colombia, Brazil, Ecuador and Peru), trust across societies is far lower (10%). What is striking is that trust levels in China are high, underlying a cohesive society and one where the ‘contract’ between the government and its people is still intact, something that is vastly underappreciated in the West.

Still, this generalized lack of trust in government and high variance in trust across societies has many implications for politics and commerce. The PEW Centre also report that in the US, France and the UK, a majority of people desire a major change in their political system (with citizens assemblies and referendums amongst the solutions proposed here, a la Ireland and Switzerland).

It suggests that in the democratic world (which according to many surveys such as one by the EIU, is shrinking), governments need to invest more in transparency, and in new ways of giving voice to their citizens – either at a local level or for example using social media to gather feedback.

At an institutional level, many institutions are not at all well understood by the people they oversee, central banks being prime amongst them. One example I often flag is the EU, whose leaders now speak of ‘European values’ but who at the same time have not thought out what this means in a tangible sense to the diverse nationalities that make up the Union, and how in a pragmatic way, it might bring them closer together.

Moreover, with respect to the new institutions of the 21st century, be they the guardians of the climate or cyber activity or bodies that will marshal new forms of money, public trust will be one of the most important criteria that drives their construction.

In commerce, there are two trends worth keeping an eye on.

The first is the rise of blockchain, and blockchain enabled means of exchange such as bitcoin. The theory behind blockchain is that its protocol works to bind two parties in a technologically trustworthy transaction or contract. More particularly, the idea of decentralized finance is that it operates outside the ambit of governments and central banks – bodies that are increasingly less trusted. We might even interpret the decision of Ecuador – a country where trust and institutional quality are very low – to adopt bitcoin as a money, as an affirmation of the above.

If you draw a graph of the decline in trust in government and the market value of crypto currencies there is good (inverse) fit, albeit with only eight years of data. So, a provocative way for governments to curb the use of bitcoin might be to boost the credibility of their own actions!

Relatedly, banking systems – which are in many cases too battered or too ill formed to be trusted – are being replaced by other more trustworthy brands. In Kenya for example, the mobile payments system MPensa is widely used and trusted, in part because it is operated by a brand (Vodafone) that is (anecdotally) trusted by Kenyans.

The idea of trust in the economy is a vast and complicated issue, my own preference is that we have governments and institutions we can trust and admire, but the reality is that there is little innovation and dynamism in today’s institutions. I suspect that instead, the next ten years will see a wave of entrepreneurship in money and democracy, some of it ugly and I hope, the sum of it constructive.

Have a great week ahead,


Transparency International

In his book ‘On China’ Henry Kissinger states that “What distinguishes Sun Tzu from Western writers on strategy is the emphasis on the psychological and political elements over the purely military.”

In that context, President Biden’s commissioning of a report on the origins of the coronavirus is more than just a fact finding project, with respected scientists like Francis Collins of the National Institutes of health as well as partisan politicians such as Sen. Tom Cotton calling for an inquiry into the possibility that the virus was generated in a laboratory. In recent days Anthony Fauci the NIAID Director has added to these calls.

There are plenty of reasons to consider the possibility that the coronavirus could have emanated from bio-experiments, not least the hitherto inability of researchers to decisively pinpoint its precise natural origins. What is striking however, is the lack of cooperation shown by the Chinese authorities in such investigations – either by the World Health Organisation or other bodies (notably calls by Australia for an inquiry have been met with an aggressive reaction from China).

It is this lack of transparency that may condition China’s relations with the rest of the world in coming years, and upon which the USA may choose to focus the ‘psychological and political elements’ of its Asia geopolitical strategy.

As a starting point on transparency, the ‘West’ is not sufficiently curious nor well informed about China, its workings and not sufficiently recognisant of the fact that China has its own deeply rooted political economy. At the same time, China is not ‘open’ to Westerners in the sense that there are linguistic, cultural and strong political barriers to Westerners living in China.

For instance, there are close to 174,000 registered foreigners living in Shanghai (a city of 26 million), compared to the fact that there are at least 5 million Chinese living in the USA. Another perspective is to consider students – in 2018 there were over 120,000 Chinese studying in the UK alone, but only 20000 Americans and 10000 French (the two biggest groups of Westerners in China) studying in China. To my mind this lack of proper two way flow in people between China and the West is one of a number of factors that severely curtail globalization.

So, China is something of a mystery to outsiders, and to a degree to its own citizens (the Tiananmen Square massacre never happened and now any consideration of it in Hong Kong is off limits). China’s economic data is also a case in point. The official line is that Chinese GDP trips along at a rate of 6-7%, though a recent paper from the Brookings Institution suggests that trend GDP is close to 2% lower than official figures, and equally the rate of investment is 7% lower.

Despite a manifest rebound in growth across the world, the health of China’s economy will come into sharper focus in coming months. There are growing signs that credit growth is beginning to slow, and many of the underlying indicators of its economy – industrial production, services activity, economic surprise indicators, car sales, freight activity and electricity generation, land activity and cement production are dropping from recent highs. This comes at a time when inflation in China is rising.

What is most interesting is that the Chinese authorities’ response to this mixed economic data is uncharacteristically (compared to the West) sensible. China is actively trying to prune back excesses in its banking and property sectors, trim crypto activity and halt the rise in its currency. In that respect it is a model for others to follow.

Diplomatically this is not the case – most of China’s neighbours tire of its needling, be it border skirmishes with India, air space incursions over Taiwan, Japan and South Korea, or trade pressure on Australia.

Against this background, the Biden administration may have a greater aim – ‘transparency’ based diplomatic pressure. By seeking to – controversially through Wuhan – shine a light on the lack of openness and transparency in Chinese politics the US may diminish any soft power China has, sow doubt in its intentions and potentially turn the economic screw against China. There are two ways it which this could happen.

The first obvious one is by undermining the broad Belt and Road initiative, whose momentum has slowed badly and is increasingly contested in Europe and parts of Africa. Another, second approach is to set the rules of global corporate governance. By raising the bar on corporate governance globally, the US may make it more onerous for Chinese companies to grow more aggressively and expand overseas, not to mention to limit their access to international capital markets. A global corporate tax agreement could be followed by further measures to improve disclosures on accounting and their enforcement, effectively beefing up governance and oversight. In casting the Chinese economy and its corporates as untransparent the US could impose a capital market penalty on China.

If that is the plan, what then should President Biden do about Tesla, AMC and other market darlings?

Have a great week ahead,


UNtied Nations

The most startling comment from Dominic Cummings, formerly chief adviser to Boris Johnson, in his parliamentary committee testimony on his previous boss was ‘In any sensible rational government, it is completely crazy that I should have been in such a senior position”. This and the swathe of Cumming’s performance underlines the attractions of British politics as the very best (blood) sport in international political economy. The ‘Brexit’ series has only heightened this sense of entertainment and stupefaction.

It also emphasises that many governments face fiercest opposition from within, and the degree of disorder and degradation that have beset the workings of Downing Street. Boris Johnson’s poor response to the outbreak of COVID (he was apparently writing a book on Shakespeare) is masked by chaos elsewhere, and the absence of both decisive international leadership, and a coordinated global response to the crisis. As I write, two of the major news items refer to the lack of a coordinated global roll-out of vaccines, and to President Biden’s commissioning of a report into the origins of the virus.

To put it mildly, this is not a great way to embark on the road towards a ‘new world order’ as many politicians now term it, or the building of the post COVID economy. The success, productivity and durability of that new world order will depend very much on the kind of ‘rules of the game’ and institutions that marshal it. As the recent cyber-attacks on an oil pipeline in the USA and on the Irish health system show, we do not yet have frameworks in place to deal with the negative outcomes of new technologies.

Democracy, the mechanics of government and institutions need massive investment.

In the ‘new order’ we will need institutions that can bring order to issues such as ‘the future of money (digital currencies, crypto)’, ‘cyber warfare and cyber crime’, policing climate damage’, ‘the incorporation of mental health into healthcare systems internationally’ and genetic editing, to name a few of the challenges looming on the horizon. In this context the crucial question, given the context of a multipolar world driven by very different values, is how to realise the institutions of the 21st century. Here, I can think of maybe four options.

‘Crash and crisis’ – the first option follows the thread of recent history, in particular the policy responses to the global financial crisis and the euro-zone crisis where apparently obvious risks and imbalances caught policymakers off guard, and where they then scrambled inelegantly to put in place rules so that a debt crisis could ‘never happen again’ (I give it three years).

I worry that a major and catastrophic (in terms of resulting human fatalities) cyber-attack could be the catalyst that, following a direct military response, forces the introduction of ‘rules of the game’ for cyber.

‘East versus West’. It is worth remembering that the current international institutional order (i.e. UN) has its origins in the desire of the prospective victors of the second world war to shape the post war world order, and the location of institutions like the UN, IMF and WHO is testament to that balance of power. More recently as the economic centre of gravity in the world shifts, we are beginning to see China both infuse itself into the bureaucracy of the UN (it controls a number of committees) and cultivate Asia centric institutions such as the Asian Development Bank. A world where we have ‘Western’ and ‘Eastern’ multilateral institutions would be a truly divided one, though there is the hope that these institutions could speak to each other, and that this dialogue might be facilitated by smaller nations from Switzerland to the UAE.

Multiple Actors – Two cojoined elements of the ‘new world order’ that are striking are the facts that the challenges posed by innovation and technology (genetics, data, cyber) are closely tied to the corporate and financial worlds and those corporations are of such a size that they are now important global actors in their own right (25% of US stock market capitalisation is made up of the top five technology companies). Under this approach, the institutional solutions to climate damage are collaborations between disparate actors – mayors of large cities, large strategic corporations (i.e. Microsoft), governments, activists and some universities.

‘Santa Fe’ – a variant on the above approach is that it is driven by experts, from very different fields and who bring both a specific expertise and an appreciation of the interlinking causes of many of the challenges the world faces. I term this approach the ‘Santa Fe’ one after the Santa Fe institute which is likely the exemplar in applying a cross disciplinary approach to complex problems and systems. In many ways this is the most enlightened approach to building the institutions of the future, though a somewhat less democratic one.

I suspect that this last option is the least likely. World wars spurred the creation of the League of Nations and the United Nations, let’s hope we don’t need the world to get worse so that it can get better.

Have a great week ahead,



On February 25th the Zuger Woche newspaper popped through the letterbox with the front page headline, ‘Bitcoin – was ist das?’ (German is so alike English that readers need no translation). I was sufficiently struck by the headline that I took a photograph (now posted on social media), the reason being that Zug is known as the epicentre of Europe’s ‘Crypto Valley’, with growing concentration of crypto currency firms establishing there. While it’s not quite the same as Le Monde asking, ‘What is the Mona Lisa’ the headline does illustrate the disconnect between new areas in finance and technology and the ‘real world’.

Having written about crypto last week I had little intention of returning to the topic this week, though the collapse in the crypto complex is worth a few words (Ethereum halved in value in about four days). The extreme volatility confirms that bitcoin and most of the other crypto currencies are not money, and likely have no economic role (blockchain, tokens may be different) and as an asset class could best be described as a ‘bauble’ – a tacky trinket of an asset. Even tacky trinkets have their place, but in the case of finance they lie somewhere on the asset spectrum between art and race horses.

Having rubbished bitcoin, there are two other more important points to make. The first is to reiterate last week’s note which is to restate that there is a storm brewing between centralized finance and decentralized finance. Last week’s crypto volatility was spurred by China curbing financial institutions’ use of crypto currencies (twice announced), and by the US Treasury’s move to draw cryptocurrency holdings into the remit of the taxation system. Note also that this summer the Federal Reserve will launch a discussion on digital currencies.

Bitcoin, whose coding incorporates a news item regarding the global financial crisis, is an affront to the staid world of central banking and a threat to governments’ taxation programmes, and indeed to the probity of financial systems. As such, the crypto world should continue to expect attacks from finance officials. The exception may be the likes of Switzerland, where, in the case of Zug the authorities have set out the technological and regulatory backdrop for a new eco-system to grow (Zug allows taxes and train fares to be paid in bitcoin).

The second point to garner is that despite a number of policy moves, the crypto complex is still standing. I am not sure if this can be attributed to the workings of the decentralized finance system (I don’t know enough about it), or its lack of liquidity and more simply to the risk appetite and deep pockets of those who invest in crypto.

I wont dwell any more on crypto. Back to the Zuger Woche, whose editors have reinforced a trading strategy – my rule is that newspaper, and magazine covers are often a good, contra indicators of market and economic trends.

In a previous note I have highlighted how magazine covers can often offer the best guide to the future – though upside down. I am thinking of the famous BusinessWeek cover of August 1979 that proclaimed ‘The Death of Equities’ before the beginning of the 1980’s bull market, the 2014 Time magazine cover with the headline ‘Can anyone stop Hilary ?’, or the Economist cover ‘Brazil takes off’ in November 2009 just before its markets collapsed, and then ‘Has Brazil blown it ?’ in September 2013 as the country was about to boom.

The staff at the Zuger Woche just about got it right, on February 25th bitcoin traded at 55,000 and pretty much stayed close to that high level until the recent stumble. I will keep an eye out for any Zuger headlines that worry about the bitcoin collapse as a sign to jump into bitcoin.

Another related trading signal is the IPO (initial public offering) as a sign that a trend has peaked. It was the case with the mining sector and Glencore (a Zug company!) in 2011, and the recent market listing of crypto trading firm Coinbase (its down nearly 40% since).

In both cases – newspapers and IPO’s – the common factor is that the public are the last to discover financial innovations. Robinhood’s IPO is next week. Buyer beware!

Have a great week ahead,


It will never catch on!

When the euro was introduced just over twenty years ago, there were tales of people around Europe refusing to exchange their national currency notes for the single currency, on the basis that the euro ‘will never catch on’. When the hacking group Darkside ransomed the dataset controlling the Colonial pipeline last week, the ransom was paid in a cryptocurrency.

These two, different tales from opposite ends of the ‘money’ spectrum tell us much about how finance, and money in particular is evolving. At one end, we see the development of a new, traditional money (euro) and the centralised financial and capital markets (to an unsatisfyingly incomplete degree), that go with it. At the other end of the spectrum is decentralised crypto finance, that exists on a largely anonymous, unregulated way beyond the ‘old’ global financial system.

These two worlds are soon set to collide. Regulators, witnessing the speedy rise of cryptocurrencies, the lurid ways in which they are traded (e.g. dogecoin) and the threat they present to the incumbent financial system, will I suspect soon take a heavier hand in overseeing the architecture around crypto currencies like bitcoin which currently can’t be regulated, though the infrastructure or architecture that trades it can be overseen.

For context, these two approaches criss-cross many other related debates – the rise of sophisticated organised crime, the future of the dollar as the world’s reserve currency and the need to build emerging market financial systems that can curb corruption.

A potentially decisive development is the acceleration in the rollout of central bank digital currencies (CBDC). Central banks are set to issue digital versions of their currencies to accompany outstanding reserves and bank deposits. Theoretically, central banks will give each of us a retail account, and households can exchange money directly with them (as opposed to going through the banking and economic systems). The logistical and communication aspects of this project will be fiendishly complex to the extent that ‘it will never catch on’ echoes through my head.

It is however, catching on. Nearly twenty million Chinese are hooked up to an experimental digital yuan run by the People’s Bank, whose intention is that the 2022 Winter Olympics in China will serve as a showcase event for the digital yuan. Small, advanced economies – notably Switzerland and Singapore (not forgetting the Bahamas’ Sand dollar) are to the forefront in planning digital currencies as is the Bank of England, which egged on by the strategic urgency created by Brexit, may be the first large central bank to roll out a digital currency (the Fed and ECB also have blueprints).

It strikes me that the ingredients necessary for this sort of manoeuvre are a well banked and financially literate population, one that is well penetrated technologically, and a central bank with a very good policy and regulatory brains trust. (I attach a link below to a good overview from the BIS)

Digital central bank currencies can achieve a range of aims – from making the transmission of money a cheaper and faster process (though I am not at all sure that this is good for payment companies and banks), a potentially more secure banking system, and the possibility to rebuild decrepit banking systems (stablecoins – that are linked to an underlying asset/currency – can play a role here). Two other factors are prominent.

One is the ability of central banks to better tailor monetary policy. As it stands, quantitative easing is delivered through financial markets. With a digital central bank currency where households have retail ‘accounts’ at the central bank, it can drop money directly into household accounts, with even a bias towards certain types of households. For example, if the central bank decides that families with two children tend to have a particularly strong impact on the economy then it can funnel relatively more money to them.

The other aspect of the CBDC that deserves greater attention is the enhanced power that it will give central banks. In opening up accounts with the public and businesses there is the risk that central banks assume a Leviathan level of control over financial systems, and to a very large extent subsume them. In China where the government aggressively policies social media content, it may seem automatic that an institution like the central bank can have immense power over people finances, and to an extent act like a fiscal authority as well.

So, if central bank independence and their outsized role in the political economy will be called into question, the counterveiling argument, for the larger central banks at least, is the geopolitical value in rolling out digital central bank currencies. Indeed, China’s announcement that it was advancing its digital currency project has prompted the Fed and the ECB to flag their own programs.

This trend raises many questions, the most prominent of which is the long term role of the dollar. What is perhaps more pertinent is to think how the architecture of central bank digital currencies will evolve – to what extent will central banks have power over household finances and economic behaviour, and to what extent will digital currencies change banking systems (I half suspect that the Chinese authorities’ attempts to rein in Alibaba is conditioned on its plans for the digital yuan).

Two of the important structural issues are outstanding. One relates to emerging countries, whose currencies and relatedly central banks are not as liquid as the ‘old’ monies – will they try to launch their own digital currencies or will we see competing waves of dollarization, euroifciation and yuanificiation across countries like Argentina, Serbia and Malaysia? What is promising here is that countries like Colombia and Uruguay are already active in terms of either mobile payments systems or digital currencies, and in Africa Kenya’s MPESA is a notable digital success story.

The second issue relates to the way in which ‘centralised’ digital currencies will interact with decentralised finance (cryptocurrencies and stablecoins). There is a vision of how these systems can join harmoniously together (see Giles’ excellent DigitalEconomist post on this below). The concern is that by definition the evolution of the crypto world is happening at such a rate, and in such a disorganised way that it presents a threat to the established financial order, and that the two systems grow in parallel, competing ways.  It is an exciting and potentially very messy clash, though ultimately CBDC’s might just catch on.

Have a great week ahead,




Forecasting is difficult, especially the future

Nils Bohr, the Danish physicist is rumoured to have stated ‘Prediction is very difficult, especially if it’s about the future!’. I agree.

Last March with the pandemic in full, terrible flight, I laid out three scenarios for how the coronavirus hit world and its financial markets might develop (https://thelevelling.blog/2020/03/28/why-did-nobody-notice-it/). To a certain extent, each of my optimistic, medium and pessimistic scenarios played out – such was the unpredictability of the virus and the ways in which it and other forces caused economies and political systems to contort themselves.

In particular, my prediction of a nasty, second wave was largely correct –

Under this ‘pessimistic’ (20%) scenario, much of the world’s workforce is disrupted by the virus, and second waves become the norm. Social unrest, political disunity and a breakdown in diplomacy between nations (US and China for instance) are some of the resulting side-effects. Monetary and fiscal policies cannot contain the full effects of bankruptcies and unemployment, to the extent that central banking ‘accidents’ crop up. The 1930’s is the nasty template to follow here. Property markets and alternative asset classes like private equity are hard hit

What is striking is the part I got wrong, that financial and market collapse was not the natural consequence of the second wave of COVID and the economic damage it has caused. That much is due to the speedy arrival of vaccines, generous fiscal packages and the seemingly never ending supply of central bank liquidity. This last factor is the one that has made the difference between an ebullient market environment and a cruel and testing real world.

In last March’s note I wrote that the distinguishing feature of the coronavirus’ passage through societies and economies was its speed, and this continues to be the case. Vaccines have been developed at a record pace, in many countries – the US for example – the economic rebound is speedy and the adjustment of businesses to a more digitally driven economy has been rapid.

With vaccination rates rising quickly in developed countries – Switzerland and France for instance are accelerating their programs – it is now time to take stock, and offer a few more predictions, or at least frame some broad scenarios.

As background, we know the following ‘truths’ in the light of the coronavirus crisis. Central banks continue to be the force that holds markets together and loftily above the reality of an at times wretched world. In coming weeks, the beginning of the debate on the Federal Reserve’s tapering strategy may induce more volatility.

Then, at a country level we do not yet know what kind of ‘model’ has best withstood the side-effects of the virus, though it is clear that populists (Modi, Trump, Bolsonaro for instance)  struggle with the health, social and economic effects of the virus.

In addition, the rise of the digital economy and manifest changes to the way we work are increasingly well understood. What is altogether less welcome is the general lack of collaboration between nations (the spat between Britain and France over fishing rights near Jersey is another example of this), and the emergence of a steadfast geopolitical rivalry or ‘Great Game’ between the USA and China (and Russia), that increasingly incorporates a scramble for scarce resources (rare earths, computer chips, and the Arctic for example).

Looking ahead, pent up demand and hefty fiscal and monetary stimuli, together with the fact that different countries are exiting the coronavirus crisis at different times, and the background factor that the crisis begun at the end of one of the longest periods of expansion in economic history, makes forecasting the near future all the more difficult. Notwithstanding that I can think of three scenarios to bear in mind till the end of 2021.

‘Brave new World’ (30% probability)

The ‘Brave New World’ is one of extremes. In this scenario, the large economies have emerged from the coronavirus and growth is barrelling forward. Despite manifest inflation, central banks are slow to rein in activity. Investment in new technologies is booming – Europe leads in green technology, the USA has a 5G revolution and China is the quantum computing leader. Central banks introduce digital currencies faster than many think necessary, drones become the frontier military technology and a debate begins on a new world institution to police the internet. Climate change becomes a significant driver of security across Africa and Asia.

In finance, investors increasingly differentiate between ‘new’ industries and companies and ‘old’ ones, such that many long established banks, consumer brands and energy companies trade at record high dividend yields. At the margin, asset managers and large family offices build portfolios that include sizeable private asset portfolios (private debt and venture like investments), crypto currency and stablecoin portfolios, agriculture centric assets in Latin America.  

High food price inflation slows growth in many emerging countries, and in the developed world, falling bond prices cause pension fund crises across Europe.

‘Two Armed Economist’ (45% probability)

This scenario is more probable, but less clear – if that makes sense. The reason for this is that once the initial ‘post-COVID’ bounce is over, we will enter a world where imbalances are met with market and policy responses, and overall economic and market outcomes will be volatile. For example, it is now clear that the Biden administration is reacting to wealth inequality in the way it is framing fiscal policy, and that in addition extreme price moves in eclectic assets – from Ethereum, semiconductor chips to lumber – are causing real world economic pain and confusion.  

This pattern of ‘equilibrium’ building continues – in many countries economic activity becomes better distributed away from capital cities (Paris to Bordeaux, Dublin to Galway) and across regions (Amsterdam to Barcelona, Zurich to Nice?) such that there is a new wave of infrastructure spending on telecoms and public services, and property market growth follows a similar path. There is a slow but meaningful revolution in healthcare and education, and at the universities level, the multidisciplinary ‘complex systems’ approach is in vogue (again, following Nils Bohr’s example).

In markets, the lingering coronavirus (and inflation) slows growth in emerging markets, the trend towards the democratisation of risk continues and the apparent rise of inflation causes both the major asset classes, developed world equities and bonds, to underperform somewhat. The surprise is the ongoing failure of the dollar to rise, though printing presses may have something to do with that.

‘Reckoning’ (25% probability)

A reckoning scenario, where many of the risks that are building in the global system (climate damage and super high debt levels) begin to erupt, is in my view likely between now and 2024, but just not in 2021 (I sound like a two armed economist or a central banker!).

This scenario will most likely develop around the permanent effects of the coronavirus on the labour force, a macro environment characterised by stagflation, which in turn leads to widespread popular discontent as real wages fall. In such an environment, fiscal policy is effectively spent from the recent rounds of stimuli, and monetary policy is rendered ineffective by rising inflation and low growth. As such markets begin to price in the risks associated with very high debt levels and a credit crisis ensues. In this scenario credit and broad equity markets falls by up to 20%, with short-term government debt in developed world countries gaining. ‘Democratisation of finance’ type investments suffer a huge liquidity drawdown that produces a numbing ‘democratisation of risk’ retail investment crisis in the US and China.  

This is a sobering scenario, but at least it may not play out just yet, not next week anyway.

Have a good week ahead, Mike

Grün und Eisen

In last week’s note I wrote about the ‘2034’ style prospect of the next world war, ostensibly between the world’s dominant power the United States, and the rising power, China. In the back of the collective minds of those who think about such scenarios, is the rise of Prussia in the 19th century, and by extension, the rise of Germany in the early 20th century, with the resulting two world wars.

We could trace the rise of Prussia (and Germany as we know it) back to a speech in September 1862 by Otto von Bismark on the issue of German unification where he stated ‘The position of Prussia in Germany will not be determined by its liberalism but by its power … Not through speeches and majority decisions will the great questions of the day be decided—that was the great mistake of 1848 and 1849 but by iron and blood’. Bismark’s ‘blood and iron’ came to define Germany (not to forget other factors…I have Fritz Stern’s ‘Gold and Iron’ on the shelf near me).

It may well be that other countries neglect the lessons of ‘blood and iron’ and that it becomes their geopolitical mission. What I find interesting is that as a phrase it no longer defines Germany, something that is exemplified by the rise of Annalena Baerbock as the leader of Germany’s Green party, and by the rise of that party itself.

Fusty, geopolitical hawks won’t be happy with this. The Germany of the ‘well sealed windows’ to use Angela Merkel’s characterisation of her country, is one where only one sixth of the army’s tanks and helicopters are operational and the army has a major recruitment problem. Worse, most of Germany’s politicians seem to want to accommodate the actions of Vladimir Putin, offering dialogue whatever the provocation. The hawkish response is for Germany to cut off the Nord Stream II gas pipeline, invest heavily in its army and wait for the Russian tanks to come.

For better or worse, that scenario is unlikely to come to pass. While much of the international press focuses somewhat mistakenly on whether Marine Le Pen can supplant Emmanuel Macron as French President in 2022, the future of Europe lies in the hands of the successor to Angela Merkel. From afar it seems like a contest between a group of colourless, older men and Annalena Baerbock. While she enjoys a high rating in the polls, it may well transpire that Baerbock ends up leading the junior party in a coalition government. Still, her arrival on the political stage has at least three important messages.

The first is that the Green Party is moving towards the centre of the political stage in many countries. This comes at a time when banks and central banks are embracing ‘green investment’ and when many mainstream political parties are adopting the environment and the fight against climate damage as a core policy issue. Commensurately, Green parties across Europe (apart from Jill Stein and Tom Steyer the USA does not have a green party worth speaking of – though corporate America is very active here) are beginning to focus more of their attention on non-environmental centric policy issues. A good example is the recent interview that Baerbock gave to the Sunday edition of FAZ (Frankfurter Allegemeine Zeitung) where she gave a balanced centrist view on foreign policy.

Related to this is, in the context of ongoing severe climate damage across the planet, the hitherto failure of Green parties across countries and potentially across continents, to better coordinate amongst themselves. Arguably, the green or environmental cause is the only one that is universal in the sense that it is a risk all countries face, in the same way though to different extents.

To that end it is surprising that Green movements across countries are not better coordinated. This might be due to the fact that Green movements in individual countries have idiosyncratic founders, and that increasingly green policies are being adopted by centrist parties.

The second lesson from the rise of the Greens in Germany, apart from what it says about voter fatigue with incumbent political parties, is that it demonstrates the idea that values are becoming an important driver for both voters and consumers. Regular readers will know that I think that globalization is giving away to a multipolar world where large regions are defined by increasingly different ways of doing things or values.

Amongst them, Europe, led by Germany is driving a value set that prizes the green economy, protection of its citizens from the negative side effects of technology (i.e. data and AI). One of the great challenges for the first post-Merkel government is the extent to which it prosecutes this approach, notably in the way countries like Hungary are wilfully out of step on issues like the treatment of women, minorities and the respect for the rule of law.

The third factor to watch is how the deeper involvement of the Green party in German politics transforms German industry, so that for instance it makes Germany the world leader in energy cells and battery technology and vaults the German car industry into a position of dominance in electronic vehicles, not to mention its energy dependence on gas imports from Russia.

If all that can happen, in years to come we will speak of ‘Grün und Eisen’.

Have a great week ahead,


2034 – are we already there?

With 100,000 Russian troops massing on the borders of Ukraine and enjoying a buildup of supporting airpower and logistics, I was happy to receive Admiral James Stavridis and Elliot Ackermann’s cheerily entitled book ‘2034 – a Novel of the Next World War’ through the letterbox (with thanks to Michael Levitt).

The book outlines how a potential naval focused war between China and the US might play out. It is a fun read though also an unvarnished appeal for the USA to spend more on cyber capabilities, and at times ascribes a tactical naivety to the US navy that is implausible.

While there is a cottage industry of writers opining on the ‘next’ war in the South China Sea, Stavridis is well qualified as a warrior and scholar. From my own non-military perch, the book emphasized at least four things about the ‘new world order’ that Xi Jinping references at last week’s Boao Forum.  

The first of these is that clusters of books that warn against coming wars, may eventually be worth paying attention to. The outstanding example here is Erskine Childers’ ‘The Riddle of the Sands’ which intricately unveiled the contours of how Britain was vulnerable to a surprise attack by the German navy (a trajectory later enacted by Maldwin Drummond in Rune VII).

A related thought is that history repeats itself, which is why the argument of Graham Allison’s ‘Thucydides Trap’ is a seductive one. In addition, reading Margaret McMillan’s ‘The War that Ended Peace’ I was struck by the inexorable buildup of navies (principally Germany and Britain) in the early part of the 20th century (that Norman Angell also flagged in ‘The Great Illusion’) and the parallels between this phase of history and the growth of the Chinese navy, which on number of ships alone is bigger than the American one.

The third point is that Stavridis and Ackermann have their timing all wrong – today it already feels like we are close to a ‘2034’ type scenario. New geopolitical ‘gangs’ are forming – the Quad (Australia, Japan, India and the US) and the SCO (China, Pakistan, Russia…with guest appearances by Iran), and China in particular is at odds with most of the countries in its geopolitical hinterland (notably India where border skirmishes have been followed by cyber attacks).

Add to that the growing effectiveness of drones on the battlefield (as witnessed during the brief war between Azerbaijan and Armenia) and talk of ‘quantum warfare’ as the ‘next big thing’ and the future does indeed look bleak.

In that context, there are maybe a few other points to set straight. First, and this might be my markets background talking, but there is so much discussion of a grand naval battle in the South China Sea, that it is unlikely to happen. A piece of grand naval theatre has few winners. Instead, look at the way that Hong Kong has been subsumed by China, with only a whimper from the West. China’s approach is multifaceted, based on constructive ambiguity.

This provokes a second point that in the future we will see fewer outright wars, but a lot more conflict and tension (over ‘rare places and rare materials’, my February 27th note).

In this scenario, outright war takes a backseat to strategic contests – where cyber power, soft power and in particular financial power are brought to bear on rival nations and constellations. This is especially the case with digital currencies, where the People’s Bank of China’s trial roll out of a digital yuan (Digital Currency Electronic Payment, DCEP) in cities such as Shenzhen, Chengdu and Suzhou has ignited a debate as to whether this is, in part, a maneuver to supplant the dollar as the world’s dominant currency, and also threatening the place of other currencies such as the pound.

Reflecting this, the Bank of England and Treasury have announced the joint creation of a Central Bank Digital Currency (CBDC) taskforce to coordinate the exploration of a potential UK CBDC. In my view this ups the ante in the roll out of digital currencies and underlines the notion of ‘money is power’. It does not mean that the dollar is in demise – digital currencies from central banks come at a cost in the sense that the central banks gain ever more information and control over economies and transactions. For this reason, I am not sure that African companies for instance would prefer – a digital dollar or digital yuan?

To close out the ‘total war’ loop, the ruble is one currency that is unlikely to transplant the dollar or the pound anytime soon. Indeed, it oscillated last week on every flex of the Russian army’s muscle. As I finish writing this note, the Russians have pulled back from the Ukrainian border – possibly because the terrain is still too muddy for a decent tank charge, but more likely because they feel they have sent a message regarding NATO enlargement and the Russian view of Ukraine’s geopolitical role.

The real question is – what will Russia be like by 2034? By then Vladimir Putin will still have two years to run on his elongated presidential cycle…who knows what he will have gotten up to?

Have a great week ahead


Baldwin’s Beard

Baldwin’s Beard

One of the notable, recent developments in the arcane world of economics was the news that Andy Haldane, the chief economist of the Bank of England is to leave the Bank in September (to become the chief executive of the Royal Society for Arts).

Haldane is an interesting character, aware of the need to broaden the public appeal and communication of economics, and who has a gift for the obscure but telling anecdote. For instance, in one paper on lending he highlighted how the beard of the 12th century King Baldwin II of Jerusalem (originally from the north east of France), was used as collateral for a loan. Then, in an address to the influential Jackson Hole central banker gathering, Haldane delivered a paper called ‘The Dog and the Frisbee’. It says much about the dullness of central banking that the paper was greeted with raised eyebrows.

Haldane’s latest paper is on inflation (link below), where like any well trained economist he gave on one hand the reasons inflation could continue to be well contained and on the other, why there are compelling forces that drive it higher. Haldane concluded by coming out in favour of the higher inflation thesis, which may make him unpopular at the Bank – it is the fashion amongst central bankers to deny the risk that inflation could shift higher (at a time when market expectations of inflation are at multi-year highs).

I have flagged the risks of inflation to markets recently (‘Return of the Prodigal Economy’, March 27), and while volatility in the bond market has calmed, equities are encroaching on valuation extremes and market metrics like margin debt are very high. This is not yet accompanied by extremes in sentiment (e.g. complacency) but it does beg the question for most investors (institutions, pension funds, family offices and the like) as to whether equities can continue to produce positive returns. In the context of historical returns, there would have to be a very strong upturn in earnings, and a flattening out of interest rates, for equities to offer more upside.

The argument that equities have reached or are close to a slowing in upward momentum is a more nuanced one than ‘when is the next crash?’ A clue to the way ahead comes from the imprint of markets over the last year – lumber, gasoline, pork, oil, ethanol, soybeans, and small cap stocks are the best performers while government bonds, volatility and the dollar are the worst performers, a pattern that points to higher growth and higher inflation. To that end, markets will continue to be driven by the narrative surrounding the speed and ‘temperature’ of the recovery.

A more pernicious side-effect of inflation if we do see it (depends much on the velocity of money in the economy) is the impact of food prices on emerging economies. One way to think about this is to consider the UN FAO world food price index which since 2015 has hovered around the 100 level, but in the past six months has jumped to 120.

This move, should it persist, represents a high, large cost to families in the emerging world (who spend a large share of their disposable income on food staples). Add to this the high toll of coronavirus in countries like India, Russia and brazil, not to mention currency and bond volatility, and the prospect is that the coming decade could be as problematic for emerging markets as the 2000’s were glorious.

Whether this is the case or not, goes back to Baldwin’s beard. When Baldwin of Bourgogne (and Jerusalem) lived, real interest (loans) rates where in the mid-twenties, and economies oscillated from high inflation to deep deflation (the Crusades had a marked impact on land prices across Europe). There were some notable, subsequent highs in rates – mid 16th century Flanders, the reign of Charles II in England and a spike around the time of the Napoleonic wars. Despite that, the historic trend in rates has been downwards, markedly so as Western economies managed to get inflation under control in the 1990’s and as globalisation led to deeper commoditisation of prices.

The very, very big picture question then (going back to the 12th century), is whether we are at a historic low in rates, and that in certain countries they will move higher as growth and inflation finally pick up, as in some cases country risk premia rise and as the weight of a multi-century high in debt to GDP ratio is felt.  

If rates rise, it will result in one of the biggest changes in fortune across countries in decades, perhaps centuries. The emerging economic world could be at the epicentre of this because it is at the tail end of the inflation tiger. To that end, emerging economies need to think of how to recover from the deadly effects of COVID, whilst keeping their financial systems strong and stable.

Have a great week ahead


Identity Angst

Only three people have ever really understood the Schleswig-Holstein business—the Prince Consort, who is dead—a German professor, who has gone mad—and I, who have forgotten all about it. Lord Palmerston, British statesman.

Palmerston’s musing on the Schleswig-Holstein question was always useful during Brexit, to illustrate its mystery and complexity. It is even better as a description for Northern Ireland, at least in terms of how well people outside Ireland understand the complexity of its political and social problems.

Indeed, with the exception of select pockets of the USA, and oddly still fewer pockets of the UK, there are not many who comprehend or are interested in the complex history of Northern Ireland, though to its credit, the European Commission gave it great attention in the Brexit negotiation process.

This lacuna should be filled by two recent books – Charles Townsend’s ‘The Partition’ and Ivan Gibbons ‘Partition’. I do not want to repeat the arguments of these books, but rather to simply make two points in the context of vicious rioting across Northern Ireland in the last week. The first is that the kindling of the riots is partly due to the fact that the historic Good Friday Agreement has not been accompanied by an ambitious Marshall style plan for the north that could have remade its society and economy.

The Irish governments recent ‘Shared Island Plan’ is a nod in the right direction, but politically Northern Ireland’s Assembly largely exists (when it sits) to channel money from London into the local economy. No one has yet dared a radical program of change for Northern Ireland, and the consequences are being felt.

Second, to a large extent however, the rioting in the North is provoked by the uncertainty over once steadfast boundaries. In particular the unionist/loyalist community is, together with British fishermen and farmers, realising the negative consequences of the Brexit deal for which they thoughtlessly campaigned (if in doubt look up the views of Sammy Wilson MP for example). The prospect of a de facto customs border through the Irish Sea (dividing the North from the UK) and talk of a united Ireland have sown discord. It lies with Boris Johnson to fix this.

I do not think that Northern Ireland will erupt into the kind of violence witnessed in the 1970’s and 1980’s, but it is an important warning sign for the implications of Brexit for the rest of the UK.

It may also be a sign of things to come, in a world where the fading of globalisation and the disruptive effect of the coronavirus, we will see more and more signs of ‘identity angst’ where shifting feel they are no longer anchored in ‘their own country’. Ironically in the context of Northern Ireland, the ‘Scots (Ulster) Irish’ in the USA are a case in point. As a demographic group they are one of the marginal forces behind the rise of Donald Trump (remember him?).

While it is not terribly edifying to search for the next socio-political breakdown, two further thoughts are worth drawing out in this regard. The first concerns emerging economies. Last week the IMF released growth forecasts for the chief economies of the world. What was striking was the relatively sluggish forecast growth for emerging economies, with a generalised rise in poverty. A structural slowing in growth in emerging nations will go against the grain of steadily rising prosperity of recent decades, and this could provide the backdrop to a more challenging political backdrop in Brazil, Ethiopia, Venezuela, Turkey and Pakistan to name a few countries where faltering economics, identity and ethnicity are faultlines.  

The other cohort of ‘identity angst’ candidates is in eastern Europe – principally Hungary, the Czech Republic and Poland, whose status as EU members is challenged by ‘strong men’ politicians, corruption, the influence of Russia (in the case of Hungary) and ugly Sammy Wilson style views on women’s rights, the LGBT community and liberal democracy.

The growing tensions in these countries – between, at a very stylised level, liberal pro European and generally younger generations versus those with a more regressive view of their country, will become more pronounced. These tensions may produce unrest, but they also need to be tended to by the EU, which has to increasingly defend and incentivise its values.

Have a great week ahead,