FILE PHOTO: British Foreign Secretary and Conservative leadership candidate Liz Truss attends a Conservative Party leadership campaign event, at Artemis Technologies in Belfast Harbour, Belfast, Northern Ireland, August 17, 2022. REUTERS/Clodagh Kilcoyne/Pool

In the House of Commons, when members of Parliament become rowdy, the Speaker will often bellow ‘Order, Order!’ Much of the same treatment is needed for gilts and sterling, both moving in a violent manner that historically has typified the breakdown of an economic regime.

There are several lessons to be learned here – one of which is that when making policy there is a need to be cognizant of the broader economic and financial environment. A financial climate troubled by inflation, rising interest rates and dangerous geopolitics is not one in which mistakes will be tolerated.

The early schoolboy/girl errors of the Truss government mark the cumulative effect of a long process of policy neglect and geopolitical decline. The death of Queen Elizabeth II has, amongst many other things, contributed to the sense that an era has passed, and that a new, more testing one is upon us.

Wrapped up in all this is the Brexit project, which has drained the UK economy of its vitality (investment, productivity and growth have stalled badly), exhausted the patience of Britain’s international partners and debased the political climate in the UK. That Brexit is not working is a clear message from financial markets.

Another longer-term message is that Britain’s outsized role in the international economy and world stage is now over.

Some years ago, the economist Barry Eichengren produced a paper that showed that through history, as empires have declined, so too has the role their currency has played in the international economy. This has led some to posit that the dollar should start to waken as we enter a multipolar world. If Britain does prove this theory correct, there should be a long lag to dollar weakness, if that is to happen. Bear in mind that at the time of the American Civil war, one pound bought ten dollars, and this fell to 4 at the time of the Suez crisis and, collapsed to 1 now.

A further source of comfort for Americans is that unlike the UK, the USA is not breaking up. In Britain, Brexit has detonated history such that Scottish independence is now likely in the next five to ten years, the reunification of Northern Ireland and the Republic is widely discussed, and there is even an upswing in Welsh independence sentiment.

Looking ahead, the chief issues now are in the short term whether economic and financial volatility will persist, and by association whether the Truss government survives its experiment with an economic model that appeared to work in 1980’s America, and then more challengingly, what becomes of the idea of Global Britain, and logically the ‘Little Britain’ that Liz Truss appears to be trying to create.

In the short term, there are two obstacles – the volatile financial market outlook and the rupture in the credibility of Britain as an investment destination, and a major economy (for comparison – British 10 year bond yields are 4% (helped lower by renewed buying by the Bank of England) whereas that of its neighbour Ireland trade at 2.7%).

In particular the reputation of the Tories as the stewards of the economy is in smithereens. The Tories face ongoing questions regarding their closeness to Russian money, and to the London hedge funds that shorted sterling.

There is now considerable speculation as to whether Kwarteng and Truss can continue – one wag compared her disastrous round of regional media interviews to that of King John in 1216, who whilst trying to fend off rebellions and invasions, caught dysentery in Norfolk, lost the crown jewels in The Wash and died in Nottinghamshire.

Kwarteng may be defenestrated after the coming Tory Party conference, but Liz Truss would be nearly impossible for the Tories to remove, because of the simple fact that there would be loud calls for a general election.

In the longer term, the UK needs at least two changes of tack. The first is an economic model akin to that of small, advanced economies like Sweden, Singapore and Switzerland that priorities access to good education and public goods, focuses on the drivers of productivity, values the rule of law, good institutions and the people who run them (the sacking of Sir Tom Scholar from the Treasury was significant in this regard). In my view, it is unlikely that Britain will adopt this approach, even though it has been shown to produce high quality long-term growth in a range of countries (The Lessons of Little States).

The second changes relates to the political system. The distasteful chaos of the Johnson premiership and the incompetence of the Truss one have resulted in a record lead in the polls for Labour. Should they come to power in a subsequent election, one choice that may confront them is electoral reform.

Introducing proportional representation in the place of the first past the post system would radically alter British politics – it would force collaboration, more coalitions and arguably foster a more policy focused debate. Importantly it would make it easier for parties to evolve. Brexit is largely the result of deep internal divisions within the Tory party that poisoned national politics because there was no suppleness in the party system.

Such a change might re-establish growth, and a sense of ‘order’ in Britain.

Have a great week ahead,


The Filatyev Diaries

Last Monday evening I was driving along the contours of Cork harbour, not far from East Cork. The area has many claims to fame – for example, a local (Edward Bransfield) is credited with having discovered Antarctica in 1820. Less triumphantly, some local villages like Whitegate, Aghada and Farsid lost one third of their male populations during the Crimean War.

At the time, a great number of soldiers died from disease and the lack of basic medical procedures – whilst the French and British armies fought side by side against the Russians, casualties were far relatively far higher on the British side because of inferior medical equipment and practice – hence the acclaim with which Florence Nightingale’s techniques were greeted.

I thought of this recently when I read a post on the very different medical kits supplied to Ukrainian and Russian troops, respectively. Setting aside propaganda and donations from the West, the Ukrainian kit looked modern while that of the Russian soldiers could well have come from a museum or horror show. In that respect, the apparent wilting of the Russian army is not surprising.

More supporting detail on this comes from the 140 page long diaries of Pavel Filatyev, a career paratrooper in the Russian army who, driven to despair by the chaos within his regiment (in Kherson), wrote a long account of his experience in the Russian army. Armies are not pleasant places but his account of the systematic mistreatment of the Russian soldiers, their undernourishment, disorganization in battle and embarrassing under-equipment is telling, not just of the Russian army but of the Russian state. Needless to say, he is now in hiding beyond Russia.

In that context, the mobilization of largely experienced soldiers to start with, and the co opting of prisoners into the Russian army, opens up many risks – for both Ukraine and Russia. Additionally, the coming referenda on the accession to the Russian Federation of the Luhansk, Donetsk, Zaporizhzhia and Kherson regions is a sneaky, deadly moving of the geopolitical goalposts. Any attempt to liberate these areas of Ukraine would now, in the eyes of the Kremlin, an attack on Russia itself, and it has the right to respond as it sees fit.

From a military point of view, this elevates the risks around Ukraine, and in particular heightens the probability of a strategic mistake or tail event (i.e. such as the destruction of a NATO satellite or an attack on a Baltic state). Putin’s move also increases the risk of socio-political risk within Russia. As I am not a military expert but prefer to write on economic development and the rise and fall of states, I will focus on that.

The Filaytev diaries say much about Russia. It is a country that until recently had poor levels of human development, especially in healthcare and life expectancy (which has been rising from low levels). In this context, Vladimir Putin’s vision of Russia as a superpower is hollow – unless a nation can sustain improving levels of human development (through education, good healthcare, freedom of thought) it will not sustain the core drivers of growth, such as productivity. This a lesson for China, the UK and the US to follow. In China and the UK (productivity is falling) whereas in the USA life expectancy had dropped sharply (below that of China).

 In coming years, I am sure many will write about the surprisingly poor quality of the Russian army, and in the context of this note, it is simply another marker for poor quality development. This is perhaps one reason why when emerging market crises strike, they happen slowly, then very quickly. Incompetent institutions, poor rule of law and a prohibition on intelligent policy making can for some time be camouflaged by superficial growth, but all very quickly melt away in moments of stress (Russia has sadly seen this before).

The risk is that other institutions go the same way. As Putin announced the mobilization there were rumours that the highly regarded head of the Russian central bank, Elvira Nabiullina, had resigned (she had apparently tried to do the same in March). This has not been confirmed but raises the question as to the seaworthiness of the full range of Russian institutions in a stormy geopolitical climate. Increasingly, the pressure will be on Russia, and from multiple angles.

As a last word, I want to return to the Crimean War. It is not inconceivable that Corkmen from villages like Whitegate were shelled by Leo Tolstoy, at the time a young artillery officer. Tolstoy’s experience of war affected him greatly. In the context of Putin’s recent mobilization it is worth recalling some advice he gave to a young man ‘all just people must refuse to become soldiers’. Many young Russians are thinking the same today.

Have a great week ahead,



Whenever there is a crisis in Europe, and the EU has to evolve, the rejoinder goes up that Jean Monnet, one of its founding fathers said ‘Europe needs a crisis to move forward’, and Europe then muddles through. It is, however, worth noting a different point of view. Monnet’s father, a merchant from Cognac is on record as saying, “Every new idea is a bad idea.”

Monnet senior’s views would not find as much favour in Brussels as before, largely because the world is changing rapidly, and Europe’s leaders are waking up to the new to realities of the end of the globalized world system and the arrival of a multipolar world, thanks in large part to the actions of three ‘strong’ men- Donald Trump, Vladimir Putin and Xi Jinping.

Trump has sowed doubt in European minds that the US may be in political decline and that it could be a less reliable partner, Xi has awoken them to the realization that trade with China involves a double-edged compromise, whilst Putin reminds them that Europe is again challenged by uncompromising evil, and needs to combat this.

I have written many times about the gathering momentum towards the notion of Europe as a geopolitical power. What is new is the speed at which this is happening. Europe took some five years to bring order to its fiscal and economic policy, and this is still half-formed. In contrast, European foreign, security, energy and political policies have been transformed in six months. The import of this transformation is not yet appreciated in Beijing, Washington, and London.

These capitals may feel that they are better off dealing with individual governments in Europe than the EU itself. Brexit, where the EU Commissioner was the trusted negotiator for the 27 countries, showed that this is increasingly less the case, and the response to the energy crisis also shows that EU countries are better together.

In the next few years, the idea of Europe as a power is likely to take hold. Practically what this means is that it will seek a more distinctive and powerful voice (at EU level) on foreign policy and that this will be informed by the EU’s social democratic values.

Correspondingly, Europe will have a more coherent, broader defense and security policy that will spill over to the idea of industrial sovereignty – effectively Europe will be ‘self-sufficient’ or have autonomy in key defense, industrial and technological areas. To a certain degree, Europe is simply catching up with the US and China here. From an investment point of view, we should expect to see deep secular trends in green energy, environmental technologies, defense and cyber security, and consolidation across fintech and healthtech in Europe.

Sceptics may feel that they have seen it all before.

There are clear hurdles. The first is the game-theoretic aspect of shaping ‘common’ policies, and then ensuring that the implementation of these does not fall foul of political developments in individual member states (e.g. Italy). Additionally, with Germany still in a state of geopolitical confusion, much depends on France getting on with the likes of Lithuania and Poland.

The second is the implementation – for instance fostering innovation in new technologies and building a tangible sense of what ‘European values’ mean to people, are best done bottom up (a very good example is the recent launch of Democracy Next http://www.demnext.org), than top-down as is the way in Brussels.

In that respect, there are a few proving points ahead. One is whether the EC will appoint a high profile foreign affairs commissioner and give him/her additional power and institutional capacity over policy, so that they do not play second fiddle to the French and German foreign ministers. Another test relates to the nature of defense spending and, apart from all the tanks and helicopters that individual armies like Germany need, whether more is spent on ‘common’ defense infrastructure such as heavy lifting aircraft. Related to this, a further test is whether the EU is prepared to take aggressive, as opposed to defensive, action against another state. An EU coordinated cyber-attack on one of a number of ‘Internet Research Agencies’ would be a significant development.

One ‘test’ that is looming is in the realm of democracy. Europe’s leaders have talked a lot about its democratic values, and the invasion of Ukraine has brought this into stark focus. What is new is that this debate was the focus of Ursula von der Leyen’s annual address last Wednesday where she criticized ‘Trojan horses that attack our democracy from within’ and notably stated that ‘many of us have taken democracy for granted for too long. Especially those, like me, who have never experienced what it means to live under the fist of an authoritarian regime’.

In that context, Hungary is the test case. It is likely to be deprived of billions in EU funding (up to Eur 40bn), and there is growing talk of finding legal means to exclude it from the European Council, and potentially the EU. The current mood in Brussels is, given Viktor Orban’s closeness to Russia, to push Hungary very hard. 


In a very different age (2004) when the euro traded well above the dollar (1.30 in late 2004, as opposed to .999 today), Jean-Claude Trichet, the then chief of the European Central Bank declared that ‘brutal’ moves in the euro were unwelcome. His use of the word ‘brutal’ – it has a far stronger meaning in English than in French – and he, as the son of a literature professor might have known better – led to even more jumpiness in markets.

A couple of years later (July 2008), Trichet made another, school-boy error – raising interest rates in an apparent response to a spike in the price of oil. Coming one month before the biggest financial crisis in recent history, it was a clumsy move given, in any case, the tenuous relationship between the price of oil and euro-zone rates. It was also a mistake that set the scene for the rest of Trichet’s stewardship of the euro-zone during its crisis period.

It is a case study that is worth examining again in the light of last week’s ECB meeting where rates were raised by 0.75% and where the ECB expects inflation to persist above 5% through 2023, having confidently forecast it closer to 2% at the start of this year. The ECB cannot expect that the blunt instrument of monetary policy will have any effect on gas and electricity prices – both of which are driven by market micro-structures and the complexities of geopolitics.

At the same time, the ECB like the Fed, is privately aware of the embarrassing inaccuracy of its forecasts (see our note of November 2021 ‘Pantomime Monetary Policy’) and the risk that a decade of easy monetary policy has let the inflation genie loose (see property and service price inflation for instance). For that reason, I suspect that the ECB, like other central banks, will continue to lean against inflation, with the high risk that we see a recession in Europe by year end. Markets are currently pricing in 2% in interest rate hikes up to next March, even as European manufacturing activity and consumer sentiment collapse, and financial conditions tighten. Another mistake may be in the offing.

There is however an important change afoot.

In 2011, in the thick of the euro-zone financial crisis when Mario Draghi became the ECB President, he and the institution were effectively the glue holding the Union together. Many of the deep political and policy relationships at the EU were forged during the euro-zone crisis and helped to build the sense of solidarity that carried through to negotiations with Britain on Brexit, and the urgency that is now manifest at the Commission level.

To that end the EU is now evolving at a rate and a magnitude that is still largely unappreciated. It has Vladimir Putin and to a lesser extent, Donald Trump to thank for imparting a sense of urgency to the EU’s strategic deliberations across foreign, energy and security policy in particular.

In the last week it has begun to show that it can take aim at electricity(gas) prices – something that individual states could not do on their own without surrendering their moral capital (with the exception of Hungary). The EU itself will not be able to kill off broad inflation – that is the job of the ECB – but it can certainly curb the pernicious effects of the weaponization of energy by Russia, and in so doing avoid misery and the risk of social unrest. It may also need a coordinated framework for the institutional support of utilities and energy producers, many of whom are as financially stressed as the sub-prime sector was in 2009.

My own sense is that the ‘winter energy’ chaos that some speak of will not materialize in as extreme a manner as feared (nuclear, hydro powered electricity are rebounding in capacity), and that the ultimate consequence of the spike in gas prices will be to destroy the largest source of demand for Russian energy.

In that context, the EU will emerge stronger and better prepared from this crisis, in the same way as it has done in the aftermath of Brexit. As it evolves, the ECB should also examine how it can improve and adapt to a changing world.

Here I want to reiterate a few suggestions I have made in recent years, starting with diversity. Central banking is not a diverse place, made up mostly of middle-aged males. What is more telling is that all of these males, and the growing number of females that join them, are formed in the same way and look at the world in a similar fashion.

Most of the members of the policy committees of the Fed and ECB have spent their careers in central banking circles, with the odd jaunt in and out of academia. As a result there is little diversity of experience at the top of the main central banks, and central bankers are not well socialized to the implications of their policies on the outside world. In the future, in addition to greater gender diversity, it may well be useful for central banks to appoint decision makers with a greater variety of experience across industry and other related walks of life.

A really important sub-element here is to appoint policy makers with a sense of the consequences of their actions, and an ability to alter their view when it is wrong. Forecasting as they say is hard, especially when it is about the future and to a large extent the role of the central banker is about mapping and creating a vision of the economic future.

Where this vision jars with reality, policy makers should ideally be conditioned to rethink their positions or be equipped with simple devices like the Bank of England Governor’s ‘letter to the Chancellor’ (the Governor must write an explanatory letter to the Chancellor if inflation deviates from target by over 1%).

A further innovation, at least for the ECB is to give local central banks more autonomy over their economies. This will take a degree of experimentation but the idea is that depending on the structure of an individual economy (compare Ireland and Greece to Texas and Kansas), specific macro-prudential policy levers could be developed to cool or speed up local economies in the context of overall monetary policy.

My pessimistic conclusion is that many of these and other suggestions will have to wait until the next recession to get a hearing, when central banks start to prosecute QE4 to undo their most recent mistake.