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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
You’re in the army now
At a recent dinner event three people, myself included, referenced Valery Gerasimov, chief of the general staff of the Russian army, and famous in geopolitical circles for a 2013 essay where he outlined the concept of ‘total war’ as seen through Russian eyes. It is a view of conflict that covers many strategies such as cyber, border testing, propaganda, intensive social media and covert attacks, for example. This approach has been very much on display across Eastern Europe and the Baltics – the encouragement of discord in Bosnia, the hollowing out of Hungarian politics and in particular the harnessing of Belarus as a form of geopolitical attack dog. Indeed, the fact that General Gerasimov has entered our minds is a sign that the doctrine is succeeding.
An excellent steer as to the tactics of ‘total war’ is David Kilcullen’s book ‘The Dragons and Snakes’ where he examines the new, unconventional forms of conflict pursued by the likes of Russia and China. One striking example Kilcullen describes is Russia’s efforts to drive immigrants and asylum seekers through the border with Norway, the aim being to test Norway’s reaction, its border security and to generally aggravate NATO.
Total war is highly effective. The ongoing destabilisation of adversaries through unconventional means is relatively cheap and effective, especially so when many governments in the West refuse to publicly acknowledge the manipulation of the infrastructure of democracy and public life. Other efforts, such as assassinations and the incursion of drones and jets into European airspace, with the added spice of cyber-attacks, are harder to ignore. They likely amount to signs of Russia stressing and probing European defences, and most importantly, testing the commitment of the US to NATO.
In this respect, NATO should be highly focused and motivated, but in the context of its gathering in Ankara, consistent with the view that all of the institutions of the post WW2 era are unravelling, dangerously on the brink of irrelevance. The danger is that it ceases to be an alliance, and instead serves as a mere organisation.
The reasons for this are well known. Whilst military level ties between the likes of France and America are very strong, Europeans (and Canadians) fear that Europe and the US no longer share the same enemy and worry that even in a post Trump 2.0 world, the stance of the US will not revert to an embrace of NATO.
In short, if NATO’s Article 5 was to be invoked, Europeans are still (despite comments from the summit) not convinced that the US would pick up the phone. Indeed, the only person to have triggered Article 5, Ambassador Nick Burns (former US ambassador to NATO who triggered Article 5 on 9/11) has said that Donald Trump’s repeated view that he wants to ‘take’ Greenland, is ‘breaking the bonds of trust’.
To that end, many officers in European armies increasingly regard the NATO command structure as an organisational framework through which European armies can coordinate, plan and organise, and to that end it still has value. Europe is re-arming, and as Germany showed this week, balance sheets are swelling with the issue of new debt to finance defence spending. This re-armament is urgent, in view of warnings from intelligence agencies of a clash with Russia within the next five years. One nod to this risk is the upgrading at the NATO summit of the Baltic Air Policing mission to an air defence one.
By their nature, democracies are vulnerable to the tactics of ‘total war’ and the rise of social media has made populism an easy and attractive strategy, and thoughtful rebuttal a near impossible one. Two important reminders of this came last week.
Nigel Farage, who according to some is Britain’s prime minister in waiting appears to have made a tactical error in resigning his Westminster seat, so as to recontest it. Farage did so in order to head off an inquiry into donations he has received (note that the former head of Reform in Wales is serving a lengthy jail sentence for pro-Russia bribery). With the exception of the satirical independent candidate Count Binface, no other parties will contest the seat, undermining Farage, with potentially enormous consequences for British politics given the rise in popularity of Reform.
Across the Channel, where on repeated occasions the French authorities have warned of foreign influence in French elections, the French judiciary have confirmed Marine Le Pen’s culpability in a finance scandal, but effectively opened the way for her to stand in the 2027 presidential election. The court battle is not yet over, and Le Pen will face several constraints (possible house arrest or electronic bracelet). Most voters should feel disdain in voting for a politician convicted of corruption, though Nicolas Sarkozy stills enjoys an allure in France.
But, Le Pen, whom Emmanuel Macron has accused of being funded by Russia, will likely play the martyr card, that the elitist French system is set against her. She has a hard-core support approaching 30% of the electorate, and the only person who can stop her is Edouard Philippe, the former prime minister, who has been far too mild mannered. He needs to take note from the evisceration of Keir Starmer, otherwise the next NATO summit in Tirana in 2027, may be marked by Marine Le Pen leading France out of NATO’s command structure.
Have a great week ahead, Mike
Modern Times
On May 15, 1932, there was an attempted coup d’etat in Japan, led by a militant, nationalistic faction in the Imperial Army. The principal victim was the Japanese Prime Minister, Inukai Tsuyoshi. The perpetrators of the coup were given relatively light prison sentences, a pointer to the less democratic and belligerent Japan that would soon follow.
The bizarre element of the coup, which fortunately did not succeed, was a plan to murder the actor Charlie Chaplin. The thinking was that such a deed would incite popular fury in the US, and thus lead to war, in which Japan would prevail. At the time of the coup, Chaplin was watching a sumo wrestling match with the Prime Minister’s son, and thereby escaped the assassins.
This was more than lucky and in many ways Chaplin’s film The Great Dictator is a fine riposte to the destructive nationalism and totalitarianism that took hold across the world from the mid 1930’s. It is a film that still resonates today in our world of ‘predators’.
While our view of Japan today is of a placid, highly civilized country, its history in the past two centuries is a reminder of the pitfalls of isolationism, nationalism and war – concerns that are now echoing louder across the international political economy debate. It should be said at the same time that the post second world war relationship between the US and Japan is a good example of how two feuding countries can come together (Al Alletzhauser’s ‘House of Nomura’ is good on this topic).
Yet, such was Japan’s economic rebound after the second world war that America feared the rise of Japan as it now does China, and fans of economic history may know that during the 1980’s and 1990’s Donald Trump was an eminent Japan-trade basher. For instance, the April 13 1987 cover of Time magazine carried an image of Uncle Sam pitted against a sumo wrestler under the banner ‘Trade Wars – the US gets tough with Japan’ (the stock market crashed five months later).
Now, following decades lost to the after-effects of its economic crisis, Japan is undergoing an awakening, spearheaded by the historic election of the first female prime minister of Japan, Sanae Takaichi. This awakening takes different forms, a more assertive diplomatic stance on China, a ramping up of defence spending amidst greater public comfort with the idea of Japan as a budding military power. Also, Japan’s government is ambitious for its economy and has announced a record state budget of 122 trillion yen (over Eur 600 bn), and Japanese firms like Softbank are in the vanguard of the AI boom.
There are two other financial aspects of this awakening. In an attempt to revitalize the Japanese economy, the Bank of Japan had kept interest rates at or below zero for some time. It has abandoned that policy recently and with both growth and inflation picking up, bond yields have surged. For much of the last fifteen years, the ten-year bond yield in Japan has been well below 1%, but in 2024-25 normalised toward the 1.5-2% range, and is now 2.7%, whilst the longer term 30-year bond yield is 3.95%.
As one of the world’s most indebted countries (Japan’s headline public debt to GDP ratio is well over 200% according to the IMF), the effect of this is that fiscal policy is increasingly smothered by the effect of interest payments on that debt, and policy is trapped between trying to grow the economy, control inflation and not upset the bond market.
Equally the yen is grabbing attention, falling to a forty-year low this week. Indeed, it might well be lower, but traders are wary of a market intervention by the Japanese authorities. There are several factors driving this, the hedging of foreign exchange risk by investors buying Japanese assets, real interest rate differentials, and worries over the effects of expansionary fiscal policy. A costly bout of yen intervention might be close.
As Japan’s asset prices hit records for largely the wrong reasons, it serves as a reminder that many large indebted economies exist on a financial tightrope between growth and calamity. Britain is the most prominent example, but Japan is a more systematic case and over the summer could be the source of a market wobble, if not outright crisis as bond market sell-offs become more common in our ‘age of debt’.
It’s all enough to make me think of Charlie Chaplin’s depression era film Modern Times.
Have a great week ahead, Mike
Irrational Exuberance
In most countries, central bankers are anonymous bureaucrats, and rightly so. In America, this is not so, thanks largely to the size of its economy and financial markets, culture of personality and fabled role of the Federal Reserve. In the past sixty years, the chiefs of the Fed have been household names, though most of them will have been uncomfortable with this level of attention. Like the characters in the Wizard of Oz, the career of each Fed chief has been characterised by a particular character trait – Paul Volcker was courage exemplified, Ben Bernanke displayed great intelligence under pressure, Janet Yellen was scholarly, and Jerome Powell was calm and patient (with his president).
Amongst them, Alan Greenspan, who died last week at the age of 100, was the governor who elevated the Fed to its mythical status, and who through his eighteen years at the helm of the central bank, captured markets with his ‘delphic’ form of communication. It is worth repeating that Greenspan once quipped to a reporter that ‘If I seem unduly clear to you, you must have misunderstood what I said’.
At the time, central bankers spoke less to journalists and were far less transparent in their communication. Kevin Warsh the new Fed chief wants to return towards this approach though he might bear in mind that, so sparing was Greenspan in his messaging, that market watchers tried to guess changes in monetary policy from the size of Greenspan’s briefcase.
Greenspan was an unusual central banker in terms of the trajectory of his career, he had made a name on Wall Street as a consulting economist with a focus on very detailed sector level data. Through the 1987 crash, crises in Russia, Asia, Latin America and the hedge fund LTCM, he won the confidence of investors, but critics will argue that he ultimately allowed himself to become seduced by Wall Street and failed to adequately regulate it in the run up to the global financial (housing) crisis.
Many of the obituaries of Greenspan will focus on his role as ‘Maestro’ (the title of Bob Woodward’s book on Greenspan) but there is also an interesting way in which his era contrasts with our own, and the lessons it holds for the future.
First the Greenspan era (1987-2006) was one of building and growing, and accelerated globalization. In general, the 1990’s and 2000’s were periods of rising expectations, whereas today that is not generally the case across countries. A notable feature was the sense that ‘things were on the up’ in the 1990’s was the growth of emerging markets. In contrast, our era is one of vandalization of the institutions that permitted globalization, and in many countries, of a struggle with decline (Britain, Germany and possibly the US are cases in point).
Secondly, the Greenspan period was one where the USA was first amongst equals of nations and this permitted it to play a coordinating role in international economic policy. The most striking image of this came with the February 1999 Time magazine cover that marked the end of the Asian and Russian financial crises with a photo showing Alan Greenspan (Chairman, Federal Reserve), Larry Summers (economic adviser to President Clinton) and Treasury Secretary Robert Rubin, under the banner ‘Committee to Save the World’. That could not happen today. Notably, the Greenspan era was one of collaboration between nations, and also across policy and political bodies (bi-partisanship) in Congress and close coordination between the Fed and the Treasury). Today, growing distrust makes collaboration very difficult, but collaboration is essential to both avoiding and resolving financial crises.
Then, a feature of the 1990’s and 2000’s was the debate around balancing the budget, something that Republicans proclaimed as sacrosanct, but that only Democrat Robert Rubin achieved. In particular, Greenspan was critical of George W Bush for his governments’ lax approach to fiscal matters. At very least then, Treasury Secretaries tried to rein in budget deficits, and generally talked a good game around this. Today, public finances in nearly all the major economies are on cruise-control for fiscal ruin. In the major economies budget deficits register 5% or more, something that would historically be associated with a bad recession. Debt levels, at 100% (to GDP) would have been unthinkable to investors and policy makers in the 1990’s.
If today’s world is an ‘upside down’ version of the 1990’s, then the challenges that Greenspan faced are germane. One risk is that there is a bubble in AI-driven stocks, and the range of market valuation and investor behaviour indicators are tipping levels not seen since 2000 (and 1929!). I can recall a debate in the late 1990’s when the Alan Greenspan Federal Reserve pondered publicly what it should do if there was a bubble in the stock market, the inconclusive outcome of which was that bubbles were very difficult to identify, so it was best to do relatively little, but to then actively mop up the mess once the bubbles burst.
Many central bankers will still agree with this approach, and the context has changed in important ways. The technology behind this bubble is strategic and it is very clear that firms like OpenAI and Palantir are closely aligned with the US government for example. AI is also the principal source of investment led growth, and is thus a sacred economic cow, even though it will swell private sector indebtedness. As such few central bankers may want to puncture this bubble.
This week’s volatile price action in technology stocks (South Korea’s market fell by over 10%) suggest that central bankers should in fact be more vigilant in the face of what Greenspan called ‘irrational exuberance’. He faced the 1987 crash only two months into his tenure. Kevin Warsh, who wants to re-make the Fed a little more in the image of Greenspan, should pay attention.
Have a great week ahead, Mike
The Levelling 