Under Water

For sale?

A memorable childhood event of mine was a tour of a French navy submarine in Cork Harbour. At the time, the Cold War meant that the contours of the world order were rigidly set. Today, the debacle over the cancelled sale of French submarines by Australia, and the creation of a new military alliance AUKUS (Australia, UK and the US) illustrates the rapidly changing world order, and the many dilemmas this will present for Europe.  

For the second time in weeks, the US has enacted a strategic decision (the exit from Afghanistan being the first) that has been motivated by a need to face down China, that has left transatlantic relations in tatters, and whose execution has been careless.

The US led move to coral Australia and the UK into ‘AUKUS’ is yet another event that unambiguously heralds the end of a globalized world, and the formation of a multipolar one. In the globalized world the US was the singular power, it didn’t need to fear China and so dominant it provided a military comfort blanket for Europe. Now, in a multipolar world, where at least three large regions (US, China, EU) do things in very different ways, new geopolitical gangs are springing up.

For instance, the English-speaking geopolitical world will now give greater credence to the Five Eyes intelligence gathering alliance (UK, US, Canada, New Zealand and Australia). In addition, the Quad Alliance of India, Japan, Australia and the US has taken on added importance though India is getting much less out of this than Australian in terms of hardware. AUKUS builds on these relationships and helps the UK by giving it a risky geopolitical role it could not have conceived by itself. Standing off against them is the Shanghai Cooperation Organisation (SCO) whose principle active members are China, Russia and Pakistan.

More specifically, submarines have often had a costly political impact – they have for example been the centre of corruption scandals in Greece, Portugal and Pakistan/France in recent decades. The Australian decision to renege on the contract with France’s Naval Group was not without warning, but apparent assurances from Australian and American officials to French counterparts in recent weeks has understandably produced an apoplectic reaction in Paris. France may ultimately not regret losing the chance to pit itself against China in the South China Sea, but it is upset that its stock of power in Washington has been diminished.

If France feels aggressed by the Australian-US move, think of how China may react. The underlying threat behind the US deal to sell submarines to Australia is that, as some speculate, nuclear weapons might follow. Indeed, the blueprint for the next development wave of the US navy, called BattleForce 2045, is heavily focused on manned and unmanned submarines, at a huge financial cost.  By 2045the plan is that attack submarines will be the largest component of the US navy, with dozens of Extra Large Unmanned Underwater Vessels (XLUUV’s ) buzzing the seafloor.

As it stands, China has a numerically larger navy than the US, but a far less proficient one.

The kerfuffle that the AUKUS announcement has created diminishes any sense of surprise – China has at least a decade to prepare for the arrival of Australia’s nuclear submarines! It can do several things – for example shift trade and financial flows away from Australia, build more island bases in its maritime hinterland and invest more in hacking naval vessels (see Admiral James Stavridis recent book ‘2034’).

What military strategists may be missing is that by the time Australia takes delivery of its new American nuclear subs, the demographics of China will have dramatically changed in that there will be many older, retired people, and as the recent case of Evergrande suggests, China could have suffered a sharp economic downturn (which would also sink the Australian economy). Both trends suggest that economics rather than submarines will determine the outcome of the strategic contest between the US and China.

The result of this deepening rivalry, and apparent estrangement of Europe by Washington should convince even the most naïve European leaders that they need to work very hard to make Europe a relevant geopolitical player. That France is the target of the latest snub speaks to its role as the most significant military player in Europe, and still underlines the reality that Paris (though Macron) is the source of political energy across Europe.

So, for Europe that challenge is to now make a credible effort to build and exercise its own power, or what Macron calls strategic autonomy. Tangibly it points toward an EU army. Europe’s ‘power’ does not need to be conceived of solely in military terms, but can be financial, diplomatic and institutional.

A range of factors will shape this. Ideally, French diplomacy will become less introspective, and would also take heed of the views of other European nations, especially Poland and the Baltic states as regards Russia. Much will also depend on the identity and views of the next German leader, but it is very clear now that Europe needs to commit greater economic resources and political energy to the many aspects of what constitute ‘security’ – from energy to cyberwar to immigration policy to heavy military transport.

The repercussions will ripple far and wide. For instance, this week Ireland chaired the UN General Assembly, and for it the AUKUS spat is the equivalent of Ireland’s cousins attacking its new best friend.

I haven’t even mentioned Russia. Perhaps they will buy the French subs!

Have a great week ahead,


Is Evergrande the End of the China Dream?

On Monday morning, Evergrande Group China’s second largest property development group will likely find itself unable to make the interest payments on a series of loans to China’s banks and will technically likely default, with trading in many of its onshore bonds already suspended. A key test will come on 23 September when the company is due to pay a coupon on a USD-denominated offshore bond.

With September being a seasonally choppy period in markets and the echo of the Lehman collapse (September 2009) audible, many will extrapolate the failure of Evergrande and talk of a coming market collapse, with contagion rippling across the banking sector. I am not so sure about this (just yet).

Most investors have had ample warning of the implosion of Evergrande (it has been paying liabilities with cash from pre-sold apartments that are not yet built), and to a degree market prices reflect this – Chinese junk bond yields are trading at 14%, the highest since onset of the coronavirus crisis (Evergrande accounts for nearly 15% of junk issuance).

While it can’t be ruled out that on Monday morning stockbrokers will circulate lists of companies that have exposure to Evergrande and the broader Chinese property market, the central expectation I have is that the Chinese authorities will permit a controlled, cushioned collapse of Evergrande where banks provide liquidity for viable projects and others are parceled off to other developers.  

This approach may also see the arrest and denunciation of its executives, the restructuring of the company (though no state bailout) and the injection of liquidity into the financial system. China is unique amongst major economies in that it has plenty of scope to stimulate its economy.

What will be far more interesting and instructive than chatter about a ‘Lehman’ moment, is the insights the collapse of Evergrande will give us into the principles and durability of the China that Xi Jinping is trying to build.

The Chinese authorities, having carefully studied how Europe dealt with its financial crisis, will not want three things to happen – that the government takes more debt onto its balance sheet, that there is widespread unrest (which unusually we have already seen last week), and that as a result, the China Dream is derailed. 

If I am correct this gives a clue as the iteration of the Chinese model (what to Westerners can be described as the ‘social democratic’, without the democracy) that Xi Jinping has manifestly been shaping since the start of this year, marked notably by crackdowns on business leaders, strategic industries and economic activities that might harm social cohesion (such as video games and private tuition), will fare. Its guiding light seems to be to avoid anything that harms or distracts the ‘common good’, and by extension the Communist Party.

To that end we can expect the authorities to respond by allocating as much financial and social pain as possible on the owners, executives and promotors of Evergrande and other property firms, plus investors in the company’s offshore bonds to avoid moral hazard.                                                    

In the context of Xi Jinping’s dictum that ‘houses are for living in’ I don’t expect a broad bail out of investors, but the authorities may either invest more in social housing, or once prices have adjusted, aid younger families to buy a home (housing affordability is just one reason for the low birth rate). The exposure that many have to property related wealth management product and to property itself partly reflects China’s under developed savings and pensions industry, and this is one area where we may see policy makers pay greater attention (in The Levelling )

If there is unrest in parts of China because of the turn in property investments, I am unsure how the Chinese authorities will deal with it. While there is currently an effort to dampen and shape reporting of the fallout from Evergrande, social media networks across the country are animated by the topic.

Given that the contract behind the China Dream is founded on the exchange of liberty for prosperity a negative wealth effect may result in a more angry populace. A wise way to deal with this would, as above, for the authorities to double down on the idea of the social welfare safety net, wiser still if Evergrande is just the first in a range of economic shocks.

Just over a decade on from the global financial crisis it is hard not to write about a credit event like Evergrande without conjuring the spectre of debt crisis past. It should be a reminder that with world debt to GDP at near record levels, the prospect of an international debt crisis awaits us at some stage. My thesis (in The Levelling) is that it happens in 2024 on the centenary of the 1924 debt conference. One of the ways I distracted myself during the early part of the coronavirus crisis was to sketch a script as to how the politics of the 2024 world debt conference might play out, though I suspect it has little chance of making it to Netflix.

Neither do I think that we are now on the cusp of a 2021 debt crisis – China has too much monetary and fiscal space, and the central banks of the developed world are hard wired to meet any market risk with more and more liquidity, until they do too much and cause a monetary accident.

The greatest near term risk is that, having avoided a major (domestically inspired) recession for a considerable period, China now suffers a simple, negative demand shock, that dents the post COVID recovery but that also removes inflation as a concern for markets (and thus interest rates remain low).

Let’s see what Monday morning brings.

Welcome to the MetaVerse

In this note, I often write about faraway places – most of which I have visited. COVID has deprived me and many others the chance to add to my list of ‘rare places’ but it may well have enabled a new land called ‘the Metaverse’. The Metaverse is something – socially and economically – that we will hear a lot more about in the future, and one that many people will struggle to comprehend. A sure sign of its arrival is that the likes of Facebook and Microsoft are pouring billions into the building out of this virtual reality universe.

To start with, I confess I have little direct experience of the Metaverse, so I write about it somewhat uneasily, but like bitcoin some five or so years ago, it is popping up on the radar in numerous blogs and newsletters and there is a sense that the metaverse itself is becoming better organised and notably, developing its own economy.

As I see it, the rise of the Metaverse is the product of technological (blockchain, virtual reality) changes as well as social ones – most of which I have found bizarre but that more oddly have been sanctioned by the social side-effects of the coronavirus crisis. They include online funerals, the virtual work phenomenon and contactless dating (there is a section on this in Chen Quifan and Kai-Fu Lee’s forthcoming book ‘AI2041’).

The Metaverse then, to have a go at defining it, is where people enjoy digital experiences (driven by augmented and virtual reality) that are real to them in the sense that they involve activity, interaction and emotion, and that are increasingly anchored by infrastructure like the digital economy, digital identities and decentralised forms of organisation.

To clarify this a bit, some examples of the Metaverse or ‘mirror world’ are online video game Fortnite, virtual reality design tools for architects, social media tools like SnapChat’s Lens Studio, augmented reality tools that superimpose an interactive virtual world on a real one like a street map (on a car windshield for instance) that has pop ups signs customised for the user, and of course the growing ‘esports’ and virtual sports industry.

To give a sense of the amplitude of the MetaVerse, in China 10% of the population (i.e. more than 100 million people) use the online game (or mobile multiplayer battle arena!) Honor of Kings on a daily basis.

So, the Metaverse is catching on. It might be cruel, careless and complacent of me to portray it as one where unhappy people in windowless rooms leap to the MetaVerse where they are happy, fulfilled and rich. I am perhaps only revealing how old fashioned I am – most of the things I like reading, travelling, running and the odd drink, are real rather than virtual experiences. For instance, a virtual marathon is nothing like a real one.

Beyond my own crude view of the MetaVerse, its growth will highlight a number of new trends and sources of friction between the real and virtual worlds. This is often the case when new eco-systems grow, let alone new universes or ‘shared-worlds’. One area of contention is identity.

In the real world our identities are largely set by factors like birth, geography, culture and education, and are largely known to the extent that they are captured by passports and id systems and by our interactions with other humans. In the MetaVerse, one can construct a new identity, which is free of geography and social ties (theoretically a more egalitarian setting), and potentially very different to the user’s real-world identity.

One lesson we learn from social media is that people behave differently online to in the real world and are often badly behaved given the cloak of a twitter handle. The MetaVerse is likely no exception, and apart from scoring systems and digital contracts on blockchain, is hard to police.

This also opens the intriguing question that, if the Metaverse does grow in terms of enjoying hundreds of millions of active participants, who governs or polices the MetaVerse?. The idealist’s answer is that it is uniquely organised through decentralised contracts and relationships, and that various avatars have their own codes of value. They may also be established by the programmers of online games and engineers at Facebook, betraying the reality that the organisation of the MetaVerse reflects the nature of those who build it.

A backlash against aspects of the MetaVerse has already begun. This is partly because in some countries – notably Japan where 40% of millennials reportedly are virgins – the use of social media and prevalence of fantasy based augmented reality, diminishes socialisation. In China, there is a backlash against the overuse of video gaming, screens and social media by the young, to the extent that last Thursday the share prices of ‘metaverse infrastructure’ providers Bilibili Inc. and Kuaishou fell by about 8%. It is an interesting, and open question as to whether the desire by the Chinese authorities to control the internet more tightly, pushes Chinese people towards the MetaVerse or limits their access to it.

One area where the MetaVerse is indubitably on the rise is the economy. NFT’s (non-fungible token) are a component of the MetaVerse (Sotheby’s announced on Thursday that two ‘Bored Ape’ nft’S sold for USD 24.4mn), and we might say that the main commodity of the Metaverse is Ethereum which effectively fuels the construct of many of the elements that make up the MetaVerse.

The Metaverse economy – where people for example buy real estate in virtual reality games or sponsor avatars – will, if futurologists are to be believed – be a big thing. Predictably we will see MetaVerse investment funds and maybe even specialist corporate finance boutiques for Metaverse assets.

What is not yet clear is the extent to which the growth and inflation of MetaVerse assets is a function of the record levels of liquidity in the global financial system – I suspect that this is the case, and the real tests of the MetaVerse may come when, and if, the Federal Reserve raises interest rates.

Have a great week ahead,


They Speak French, Part Deux

Last year, following the election of Joe Biden as President of the United States I wrote a note on his diplomatic and security team entitled ‘They Speak French’, the aim of which was to contrast the feckless Trump foreign policy team with the erudite (French speaking), principled Biden team, made up of the likes of Tony Blinken.
The hope, I thought at the time, was that the (Jake) Sullivans and Blinkens of the world would restore order and prestige to the State Department, thought the risk was that they would spend too much time debating policy papers and speaking French. This is not regarded as a positive in American politics as catcalls (‘Monsieur Kerry”, “Jean Chéri”, or “Jean-François Kerry”) to John Kerry have shown!
In the context of the fiasco of the Afghanistan withdrawal, the Blinken team is chastened, though still united (unlike the Trump crew). True to the title of my earlier note, Blinken gave several interviews to French media during the crisis but failed to heed the recommendations of the French intelligence service to start the pull-out in May. On the face of it, the USA has suffered diplomatically, and sadly has also borne a human cost, as have many Afghans.
Too many people, some of them military and security experts, have analysed the faults of the withdrawal, and here I have little new to contribute.
From a different, finance led angle, one might say that Biden is doing the right thing in finally withdrawing, and so ‘taking the loss’ as traders say, and ignoring ‘sunk costs’ as accountants say. If there is a failure, it is a deep seated institutional one – of the military industrial complex as Eisenhower termed it, though recent readers may be aware of my upgrade of the term to the Military Industrial Financial Data complex.

I suspect that much of the commentary around the withdrawal will continue to swirl around banners such as ‘American decline’, ‘end of empire’ and so on. I am not so sure about this train of thought but would also point to some of the other, potentially profound geopolitical implications.

To start in Afghanistan, the Taliban are likely wiser and more politically sophisticated than the savages that took Afghanistan in the mid 1990’s, but not by much. Their immediate aims will be to avoid international controversy (in terms of not instantly clamping down on foreign workers and Afghans with foreign ties), subsume the Afghan state or what is left of it. An economic and financial crisis may be their first challenge.

To this end, China may provocatively become more commercially involved in Afghanistan – it can source commodities such as iron, copper and niobium and may also seek to edge the Belt and Road project into Afghanistan in terms of providing physical infrastructure. Such a move would constitute a fillip to the West but China has already been warm in its diplomatic response to the Taliban. To that end the war on terror has not ended but is shifting location, whilst the ‘Great Game’ between the US and China is now well underway.

In the broader region, there are at least three broad concerns. The first is the relationship between India and Pakistan. It is widely believed that Pakistan is the progenitor of the Taliban, and while not controlling them, can certainly coordinate with them. The cold reality of this may finally break the political relationship between the USA and Pakistan, to the advantage of India.

India is a member of the QUAD grouping of countries (with the USA, Japan and Australia) and it may now deepen ties to the USA which in turn would mark the rivalry between the QUAD and the SCO (Shanghai Cooperation Organisation – largely Pakistan, China and Russia) as the one to watch in the 21st century.

The second regional implication relates to Islam itself, the perception the West has of it, and the geopolitics of Islam. To many who do not understand the intricacies of the Islamic world, the Taliban represent a severely negative view of Islam, to the extent that they discredit it, and some may use the existence of the Taliban in the debates that Europeans and Americans have on issues like Islam and immigration.

To that end, Sunni Muslim countries like Saudi may publicly at least feel a need to put distance between themselves and the new Afghan government, though this will likely drive internal tensions with their Wahabi population.

As far as Shia Islam is concerned, Iran had come close to an outright war with the Taliban in 2000 and will regard them with great distrust (so far there have already been attacks on Shia Muslims in Afghanistan), notwithstanding the way in which the Taliban have embarrassed the United States. The geopolitical implication for Iran is that it now has marginally more power in terms of its dealings with the US, and dangerously, it may feel that the power of insurgent style warfare is validated, as far as Lebanon and Syria are concerned.

Thirdly, terror groups across the world will be watching the way the Taliban have acted – their gruesome, savage tactics, their strategic patience and the ways in which they have used the vulnerabilities of Afghanistan against it. My worry is that Africa is at risk in this respect – from Mozambique to Nigeria to Ethiopia to Mali – where efforts by the US, British and French to train locals to fight are bearing little fruit and where the institutional quality of these countries is very poor. Counter-insurgency strategists and security services will have to carefully calibrate not their tactics, but strategies for fighting terror groups in these countries. 

That leads me to the issue of the strategic direction of security strategy in Europe. In the UK, which has put much into Afghanistan, the lesson is that it likely needs to become closer to key European countries (Netherlands, Norway, Sweden and especially France). From a military point of view, the irony being that despite Brexit, Britain and France are operationally very close.

The other related trends to watch for are the debate on military spending in Europe, and the emergence of a bigger, more robust European army from the cloak of NATO. Even in neutral Ireland, which has a small army in absolute terms, the Afghan crisis has triggered a debate on military hardware, and the necessary security it should adopt (there is a review ongoing). Much the same will happen around Europe, and the stance of the next German Chancellor on this area will be crucial if other countries are to step forward and match the military capabilities of France and the UK.

As a last word (I realise that this note is already longer than the usual 800 words, but I have been ‘off’ for the past two weeks), the underestimated element in the Afghan withdrawal is that it allows the US security establishment some clarity on its true objectives – countermanding Russia and limiting China. I suspect that in coming months the Biden team will take a much more aggressive approach to these countries, potentially in the form of a fulsome cyber retaliation on Russia, and the export of high-level military technology into Asia.

Have a great week ahead,