When he ran for president in 2004 John Kerry was mocked by opponents for his ability to speak French, with ‘Monsieur Kerry”, “Jean Chéri”, or “Jean-François Kerry” amongst the favourite catcalls of Republicans. Imagine the fun they will have with the new Biden administration – not only Kerry speaks French, but Anthony Blinken was educated in France and Michele Flournoy is a Francophile too.

Mike Pompeo has conjured up images of highly educated, high minded members of the Biden cabinet jaunting around European capitals debating the finer points of diplomacy with Europeans, while Marco Rubio – who has found his voice given Donald Trump is on the way out of the White House – paints the Biden team as elegantly presiding over American decline. It’s an interesting image of Biden’s team – effete, be-wigged and decked in frock coats, conversing in French. But then, so did Beaumarchais and Lafayette and they saved America.

The ‘French speaking men and women in frock coats’ are a key part of Joe Biden’s Restoration (https://thelevelling.blog/2020/07/18/the-restoration/). They will restore order, harmony and morale to institutions like the State Department, and I would not be surprised to see a senior diplomat be given the specific role of rebuilding it from the inside out.

However, if the Biden team, many of whom worked in the Obama administration, think they will find the world as they left it four years ago with America effortlessly slipping into the top seat in world affairs, they are mistaken. China has grown much more powerful and assertive (note the way it treats Australia), Turkey is an engine of geopolitical chaos (as we noted last week), and even Europe is striking out on its own path. What’s worse is that like half of the American population, the rest of the world worries that Trump (or someone like him) might be back in four years’ time.

This should impart some urgency to the Biden team. Integrating climate problems into foreign policy is a welcome start, as there is common ground with both China and the EU here, but given the need to restart economies, it is hard to envisage what meaningful measures can be introduced to curb climate damage in the near term.

The bringing together of climate policy with foreign affairs is a sign of things to come, specifically that many issues will intersect. For instance, a key part of Janet Yellen’s role will be the international diplomacy associated with the Treasury, and in particular trying to align economic policies in Europe, America and parts of Asia so that they all move in the same direction. 

A much bigger challenge is the integration of indebtedness into the strategic rivalry between the US, China and Europe. Each region, in different ways, has run up record levels of debt such that the sum total of world debt (per GDP) is pushing levels not seen since the Napoleonic Wars. The Chancellor of the Exchequer’s spending review last week underlined this. If we accept that overindebtedness can act like a financial handbrake then, whichever region can most quickly reduce its debt burden will have a head start in the strategic race to lead the 21^st century.

The lesson for Blinken and colleagues is that balance sheets rather than space wars are the most important tools in the diplomatic contest. They should study the role the Bank of England played during and after the Napoleonic Wars and the financial reforms that were made in the UK in the early nineteenth century that contributed to Britain’s rise as a world power.

One implication as far as the economic debate in the Democratic party is concerned is that there may soon be a sharp divide between foreign policy aware policymakers who wish to curb debt issuance (and keep a steady dollar), versus those (MMT – Modern Monetary Theorists amongst them) who believe that the USA can and should issue debt ad nauseum.

The same focus on the mixture of finance and diplomacy is relevant with respect to American policy towards Russia, a subject where nearly all the Biden team are united in their distrust of the Putin administration. I suspect that policy towards Russia will initially at least, focus on money flows (Catherine Belton’s book ‘Putin’s People’ is very good on this).

Even if American foreign policy becomes more foreign policy driven, I do not expect a mothballing of expensive fighter jets and aircraft carriers, not least as there are some conflicts internationally where America may re-engage.

In general, I have Africa in mind and specifically Ethiopia, which like many other countries is falling into the investment orbit of China. The contentious lesson from the Obama era is that a lack of aggressive action by the United States across the world has opened up theatres like Africa to Russia (now building a naval base in Sudan) and China. To that end American foreign policy may take on a more activist stance and, historians will look back on Donald trump as the ‘Pacifist President’.

Have a great week ahead,

Mike

In the past week Peru has had three presidents, and it seems that America is still unsure how many it will have in January. Such political volatility is not new, but a greater awareness that the destiny of individual countries is in play, is. The end of globalization and the stress test of the coronavirus crisis have sharpened the sense that some countries are stronger (Germany) and more resilient (Norway), whilst others may be in decline (possibly the Anglo-Saxon world).

Investors – in both stocks and bonds – who are used to parsing the world according to investment styles (growth versus value, new versus old economy as per last week’s note) should pay more attention to the country effect, which historically tends to be greater in periods of economic stress.

If they were to search for a case study of how the financial fortunes of a country are driven by its politics, institutions (or the lack of them) and geopolitical power, they should look no further than Turkey.

Some ten years ago, in the aftermath of the Arab Spring I conducted a survey of policymakers in countries like Egypt as to what model their countries should follow in order to strike a prosperous post-Spring path. The resounding answer was Turkey.

Its economy was seen as having a secular society, a strong economy that had benefitted from both the economic medicine administered by Kemal Dervis in the early 2000’s and the prospect of EU membership. Its foreign policy was characterized by the phrase ‘zero problems with neighbours’. All this has changed, Turkey has problems with everyone.

Turkey has become a geopolitical balancing act between an increasingly capable and active military, and an increasingly volatile economy. Turkey’s military was for a long time the guarantor of the Ataturk model of a secular society in the context of a largely Islamic population. Since the coup in 2016, the army has been unleashed – for instance it now faces off against Russian troops in three different theatres (Libya, Syria and on the side of Azerbaijan), has forced France to deploy military assets to the eastern Mediterranean, rankled Israel and caused palpitations in NATO headquarters in Brussels.

Another contradiction, which the Biden administration will have to deal with is Turkey’s use of American fighter jets on one hand, and the highly sophisticated Russian S-400 surface to air missile system on the other.

All of this is the doing of the Turkish President, who while allowing his military to take a much more active role, is hollowing out Turkey’s civil society and economy. The sacking and imprisonment of teachers and judges was a start, the rise of corruption, stark inequality and manipulation of the banking sector followed, and then came the masterful stroke of placing the President’s son in law at the head of the central bank (that has not happened in Peru or the USA). The collapse in the lira over recent months is clearest sign of the diplomatic and economic chaos unleashed in Turkey. It has recently been brought to a halt by dramatic action by the new central bank governor, but this may only be a respite.

Sadly, Turkey is dropping backwards in terms of the quality of its institutions and any sense that the economy is marshalled by a rule of law (ironically, two of the finest economists to work on the link between institutions and growth, Dani Rodrik and Daron Acemoglu, are Turkish). The risk now is that a step too far militarily, or a mis-step economically could trigger a full blown crisis, where most of Turkey’s neighbours and former allies now have an interest in seeing it (or rather its president) fail.

So, while the current trend points to a Turkey centric crisis, the lessons from it for other countries are a more worthwhile focus. One is that, in emerging markets at least a country’s currency is a telling barometer of its institutional quality. Another is that to be really powerful, a country’s geopolitical and economic power have to advance together. Notably, another lesson is that the ‘strongman’ political method has limits, and arguably these limits are costly the greater the interaction that country has with its hinterland.

To round out the thought experiment, in 2021 we should keep an eye on the dollar, especially relative to a basket comprised of the florint, rouble, lira, brazil’s real and the Mexican peso – to name some of the more liquid ‘strongman’ currencies’.  

Have a great week ahead,

Mike

Winston Churchill came upon George Bernard Shaw at a cocktail party and greeted him by saying ‘Looking at you, one would think there is a famine in England’. Shaw, whose 1926 Nobel Prize was awarded for ‘stimulating satire’, replied ‘looking at you, one would think you caused it’.

While Churchill and Shaw were never close enough to constitute a literary Laurel and Hardy, they enjoyed a respectful and very witty acquaintance. This kind of relationship made me think of the bifurcated nature of markets – where since the coronavirus crisis ‘new economy’ (essentially anything tech) stocks have been lavished with capital, while those in the ‘old economy’ (banks and energy companies) have been starved of it.

Like the clever repartee between Churchill and Shaw, last week saw a quick twist and turn in the performance of ‘technology’ stocks relative to ‘old economy ones. For the sake of background, the shift in the relative performance between the two styles of investment flipped at a magnitude of ten standard deviations, according to some metrics.

The reason for this sharp change in investor mood was the release of vaccine test results from Pfizer/BioNTech, following on the news that Joe Biden had effectively won the title of President-elect. The Pfizer result (note that the company’s CEO sold nearly USD 6mn of stock on the result) is a manifest pivot point in the coronavirus crisis, not just for markets and the economy, but for the way people will lead their lives in the next year. Mentally, it has the effect of splitting the horizon into ‘the near future’ and the ‘longterm future’.

For the ‘man and woman in the street’ the ‘long future’ becomes rosier, and enhanced visibility will allow many the chance to think of travelling and socializing freely again, a la my ‘Roaring ‘20’s’ (Oct 17, https://thelevelling.blog/2020/10/17/the-roaring-20s/) thesis.

The (health) risk is that the promise of a vaccine (it will be a year before most people in developed countries are vaccinated) will lead many to change their ‘near future’ behavior such that the positive effect of lockdowns will reverse and healthcare systems will be further overwhelmed. The sad and unnecessary effect of this will be more fatalities and deeper lockdowns (I expect Europe and the US to impose ‘decisive’ lockdowns in early January). To this end, policy makers should play down the vaccine news.

Ideally, the Biden administration whose economic mission is to ‘reflate, repair and redirect’ (as per my recent FT Wealth article, https://thelevelling.blog/2020/11/13/reflate-repair-and-redirect/) would coordinate an international coronavirus (and vaccine) response. This would involve Europe, Japan and maybe China, that would also incorporate how best to manage an internationally integrated stimulus plan. For the next two months however, we can fantasize about this.

Back to markets where the vaccine news is, across the board more unambiguously positive. The arrival of a vaccine gives markets greater clarity as to when sectors like cinemas, airlines and hotels can return to normal. For business people in these sectors there is now also a degree of clarity as to when to restart investment.

With respect to sectors like banks and energy, which have been starved of capital, the market rebound has a reflexive element in that it removes the stress of an existential risk. Some companies in these sectors are very cheap historically and may now have a catalyst for better performance. The irony is that for younger investors, who appreciate the transformative power of technology and the importance of environmentally and socially responsible investing, it is really only fusty, old world industries like banking, mining and oil that can deliver the returns necessary (assuming their valuations revert to historical levels, i.e. their prices rise) to adequately support their pensions.

It is a bitter investment pill to swallow, more so if the valuation of technology stocks has now peaked. I am not sure that it has, but the last time we saw such wild swings between the yin of ‘old economy stocks’ and the yang ‘new economy/tech’ ones, was in early 2001. We know what happened next.

While we wait for the market dust to settle on the vaccine news, let’s consider another exchange between Churchill and his Irish friend in 1923. Shaw wrote to Churchill ‘Am reserving two tickets for you for my premiere. Come and bring a friend—if you have one.’ Churchill replied ‘Impossible to be present for the first performance. Will attend the second—if there is one’.

Have a great week ahead

Mike

One of the telling quotes in ‘The Art of the Deal’ (Tony Schwarz and Donald J Trump) goes ‘You don’t reward failure by promoting those responsible for it, because all you get is more failure’.

That might also be the view of the American people, though given the very close-run Presidential election, it is hard to know what is on their minds, and what they define as success or failure. If the COVID-19 outbreak hadn’t happened, we might easily have seen a robust victory for Donald Trump.  

Previously, in the aftermath of contested elections – from 1876 to 2000, a sense of compromise has eventually prevailed. In previous elections, the vanquished candidate respects the ‘majesty of democracy’ as George H Bush put it. This time, as they say, might be different.

There is a small but appreciable risk to markets that the Trump administration and some emboldened Republicans try to thwart the orderly transition that President elect Biden might ordinarily enjoy. If this is so, it may derail the prospects for a generous fiscal stimulus, something that in the short-run could take the steam out of the recent market rally.

Beyond that the Biden team will bring a decisive change in style, that itself will transform the policy landscape and by extension, market trends.

The first of these is that Biden’s presidency will be a restorative one in that it will reintroduce the thread of Democratic policy thought (through Obama to Bill Clinton), and very importantly would restore the competent workings and full staffing of institutions like the State Department.

The idea is that the American machine of state would once again purr into action, and credibility, predictability and technocracy will be restored to the execution of policy. On geopolitical issues such as relations with China and Iran, as well as the potential for a healing in trade relations with Europe, policy will be more clear and closer to orthodoxy. Broadly speaking, this means that policy volatility should fall. This should make the ‘big picture’ less cloudy.

One area where there may be a discernible improvement on the economic side, is international collaboration. Whilst the new administration’s hands may be tied by the Senate, there is enormous scope to re-engage with other countries and to restart collaboration on economic policy. One example might be coordinated action with the EU, Japan and even China, on a global fiscal stimulus program. Ideally, this would fast forward new trade rules and structures (including appointing a chief at the WTO), better organize the distribution of vaccines around the world, and underpin central bank policy on reflation.

Another trend that will soon come more closely into view is values-based policy making. In financial markets, ESG (Environmental, Social and Governance) led investing is short-hand for this. The Biden administration, again mirroring the EU, will likely would likely focus much of its stimulus effort on infrastructure, particularly so in the ‘green’ economy.

The success of Biden’s campaign and the tenor of his potential presidency will rest in good part on the extent of the economic damage ahead. If high unemployment and bankruptcies are a reality into the first half of 2021, notwithstanding the promise of a vaccine and possibility of a fiscal stimulus, then tone of economic policy will tilt much more towards social justice.

What is much less clear is the extent to which they would consider rejigging the tax system to place a greater tax burden on wealthier Americans and corporations. Whilst this will be contested by Republicans and as a policy issue will form the basis for the 2024 presidential election it prefigures an international revolution in tax policy vis a vis global corporations, wealthy individuals, and more specifically tax breaks or asset classes like private equity. The effects of this debate will ripple through the wealth management industry from 2021 onwards.  

Overall, the task of the new Treasury Secretary, and colleagues in the Labor, Commerce and State Departments, not to mention the White House is daunting, but will be best described by – reflate, repair and redirect. Reflate the global economy, repair economic and diplomatic relations and redirect investment to the ‘new economy’.

In last week’s note I referred to a study that showed that people are the most dissatisfied with political systems over the last forty years, especially so in the two chief Anglo-Saxon countries. Mindful of the Shakespeare quote in Hamlet that ‘When sorrows come, they come not single spies, but in battalions’, more bad news has arrived.

A study from Carbon Brief that has collated data from six different research groups (e.g. NASA) to show that 2020 is the ‘hottest’ year in centuries, the Vix index of stock market stress reached highs only surpassed on a handful of occasions in the last forty years and, two academics in the US (Peter Turchin and Jack Goldstone) have recently highlighted that their political stress index is at a multi decade high, something they feel portends imminent revolution in the USA.

Add to that the re-imposing of lockdowns across Europe and a wave of savage terror attacks in France, and it is all, frankly, too much. I sense that a great many people are truly fed up with 2020.

The outlook might brighten on Tuesday, in the shape of a dashing political cavalry charge by Joe Biden and his team to re-take the White House. If this happens in a convincing way, stock market volatility will be crushed, America might tackle COVID better, the green economy should flourish, and we may even see a sense of collaboration between Washington and Brussels to produce better coordinated recovery plans across the ‘Old World’. Any result other than an emphatic Biden one will likely see us confined to stress-ridden purgatory.

I am not going to spend any more time trying to predict the US presidential election but rather want to focus a little on the nature and consequences of such a stressed world.

One is the propensity for people’s view of the world to be conditioned by stress – in general there is a tendency towards short-termism in the sense that we lose sight of longer term trends, and in addition a tendency to over emphasise dramatic outcomes. It strikes me that the media has been more than usually coloured with warnings of a repeat of the ‘2016 election surprise’, a ‘1987 market crash’, ‘1918 level health emergency’ and impending cyber wars, to note just a few examples. We need to keep at least an eye on the longer term outlook, as outlined in ‘Roaring 20’s’ (17.10.2020).

A more serious side-effect is the way in which this epidemic and its consequences will condition behaviour and mindsets. There is a growing body of research that shows that deep financial crises produce political aftershocks (for instance the ifo Institut has produced research linking the rise of radical and populist parties to financial crises).

In the same way, waves of lockdowns and economic damage will trigger shockwaves in mental health. In previous notes I have suggested that mental health will be one of the major policy issues of the 21^st century to the extent that it becomes a pillar of healthcare. This crisis will accelerate that.

In the short-term it’s hard to know what policy makers should do, and it must be appreciated that many of them are under great physical and mental stress. For instance, Emmanuel Macron, having given a very clear and important address on Wednesday evening, found himself in Nice some ten hours afterwards, making sense of yet another terror attack.

One suggestion is that with political classes in both Washington and Brussels having failed to agree a second fiscal stimulus (in the case of the US) and the implementation of the first package (in the EU) that fiscal packages be amended to devote greater resources to mental health (a few countries already incorporate the idea of Wellbeing into budgeting) and the reconfiguration of health services around this, especially if Europe at least will endure a third wave of COVID 19 after Christmas. In this way, longer term societal damage can, to an extent, be avoided.

Another proposal is that as the risk that we suffer repeated, though shorter lockdowns rises (as brakes on the impact of the virus on health systems) the way governments structure these lockdowns and communicate with citizens will change. Future lockdowns – to be glum about it – will need to have a different mix of attention to the economy, focus on mental health and the wellbeing of the vulnerable.

One example is a recent radio advert from Health Ireland that recommended ways in which people can be aware of their mental health, and keep their minds agile by reading and perhaps, learning languages. In that respect it might be that the next stimulus package comes with free access to a language course or subscriptions to online books.

Returning to Hamlet, who stated that ‘What a piece of work is man’, it is becoming clear that this health crisis will be as much about our minds as our bodies.

Have a great week ahead

Mike