One of the side-effects of the attack on Israel by Hamas and its consequences, has been the noisy invective in social media and the international stage, that has made statements and gestures by diplomats nearly impossible to craft.

In this context, one very clear statement of policy that, perhaps coincidentally, appeared last week was Jake Sullivan (US National Security Adviser) in Foreign Affairs Journal (November/December 2023) where he lays out the broad sweep of America’s diplomatic views, and the strategic challenges that lie ahead to the ‘sources of American Power’, and frankly the number foreign policy issues the US is managing.

In the article he notes that beyond geography and natural resources, ‘It is the strategic decisions countries make that matter most—how they organize themselves internally, what they invest in, whom they choose to align with and who wants to align with them, which wars they fight, which they deter, and which they avoid’.

This view tallies with many of the trends I see emerging in Europe. Some years ago, Joe Lee the pre-eminent historian of Ireland remarked that the future of small countries is a function of their strategic thinking, and in this respect the entry to NATO of Finland and Sweden (soon) to NATO are critical examples as is the overly complicated web of alliances that Qatar has made for itself. In addition, larger countries are being forced to ‘choose sides’, as we have noted in the case of Germany in ‘Mugged by Reality’.

If states are grappling with the new world order, there is yet mixed evidence that corporations and investors facing up to it.

Many are used to a world where geopolitics was interesting to read about and debate but owing to the soporific effect of quantitative easing on markets, mattered little in the scheme of things until the monetary battleships retreated. A few investment firms like Sequoia have changed their structure to better fit the multipolar world but the majority of banks and asset managers are simply still talking about geopolitics rather than acting on it.

However, if and when they awaken to a changing world, what should they do?

To start with investors first, there are two practical elements to consider. The first is that in the context of relatively high equity and corporate bond valuations, the contribution of macro risks to portfolio performance (through currency moves for example) will be higher.

The single biggest macro risk for 2024 is that extremely high debt levels (across continents and balance sheets) are ‘ignited’ by a political or geopolitical risk, if might be a dramatic climate event, the prospect of another, but even more unorthodox Trump presidency or an event in the South China Sea.

A more intellectually interesting approach for investors is to accept the assumption that the world order is changing for good (i.e. globalization is gone) and to imagine who will be the financial power houses of 21^st century. The thought experiment is aided by research work by Profs Elroy Dimson and Paul Marsh, that compares the percentage of world equity market capitalisation held by different countries in 1899 to that today.

In 1899, the UK was the biggest stock market, accounting for 24% of world equities (measured in dollars), but now comprises 4%, Germany had 13% of world equities in 1899 and now has 2.3% while Russia has dropped from 6% to near 0. In contrast, the USA made up only 15% of world equities in 1899 but is now 60%. Thus, the thought experiment goes as follows – might the US drop to 40%, could Chinese bonds 33% of developed world bond portfolios by 2040, and might a bitcoin/crypto ETF take up 3% of a typical investment portfolio?

To jump to companies, my sense is that in Europe – old companies (Mittelstand for instance) seem to not be aware of how to adjust to geopolitics or map its effect on their businesses. In contrast, new companies, especially those in the deeptech sector (quantum computing, AI, robotics as examples) are in the crosshairs of geopolitics because their innovations are prized and strategic. Notably, and this is something many young growth companies are having to grapple with in terms of where they sell their products and whom they hire. Equally they also need capital to thrive, and even in a capital starved world they must carefully choose the investors they take on board in terms of the geopolitical risks this might present.

A final world goes to a small number of (mostly large) firms that understand geopolitics and that are becoming part of its apparatus, be it in cybersecurity, supply chain and logistical networks, banking and asset management and aerospace. What distinguishes them from companies of prior decades is not so much their size and power, but their information and technical capabilities, such that governments and international institutions need to cultivate them to an extent they may not be aware of.

Interestingly, Jake Sullivan’s otherwise well written essay barely  mentioned corporations as geopolitical actors. Maybe he is missing a trick? 

Have a great week ahead,

Mike

We had expected that compared to 2024, 2023 would be a quiet year in electoral politics, but this has not been the case. Amidst a geopolitical landscape marked by tragedy and turmoil, the past week has seen two electoral events that augur well for a more coherent, and less politically volatile Europe. Last weekend, Donald Tusk’s Civic Platform party and two, quite different opposition parties in Poland garnered 248 seats in the 460 seat assembly, most likely bringing to an end the reign of the PiS.

Normally Polish general elections do not matter much for the EU, but Poland is Europe’s rising power – because of its growing economy, a fast-growing military spend, the war in Ukraine and a slowing German economy (the Polish election campaign has led to new lows in relations with Germany). Thus, this election is highly significant.

The international political effect of the election result will be to bring Poland back into the European political fold, to add heft to Europe’s policy on Ukraine and to remove a festering quarrel over ‘European values’. Within Poland it is a loss for ‘illiberals’, a win for liberal groups (women’s rights in particular, many Poles ignored the divisive referenda votes held at the same time as the election) and a realignment of Poland away from the ‘eastern awkward squad’ to a better-behaved member of the EU.

As the Polish campaign was coloured by the castigation of Donald Tusk as the ‘EU/Germany’s boy’ in Poland, he will be slow to politically embrace the EU, but as a former EU Council President, will naturally work very closely with EU leaders. Perhaps his most important task for him will be to reverse the damage to Poland’s institutions – television, media, legal arena and even the central bank. One of his first moves will be to try to remove PiS loyalists from these institutions and introduce measures to safeguard their independence.

The election is a clear positive for Ukraine, not simply in terms of continued logistical support for its war effort, but also in terms of its long-term ambition of joining the EU. Hungary and Viktor Orban are clear losers and will find themselves isolated in many EU debates. In a cruel week for geopolitics, Orban chose to mark his allegiances by very publicly meeting Vladimir Putin in Beijing. In my view it is time for the EU to severely sanction Hungary, and to think of a mechanism to expel it from the EU.

The significant development is that we may start to hear more about ‘Hungrexit’, and now, less about Brexit.

On Thursday night in the UK, Labour overturned two huge Tory majorities in Mid-Bedfordshire (a Tory seat since 1931) and Tamworth. If these results were repeated in a general election there would be a landslide victory for Labour, and an end to the Tory government since 2010. The next UK general election (less than a year away) is now Labour’s to lose.

At the risk of showing my age, the rise of Labour puts me in mind of the early Blair years (I recall walking past Downing Street the day after Tony Blair came to power in 1997). What was telling in the run up to that was the quality of the Labour front bench, and the extent to which ‘New Labour’ prepared for government (taking ‘change management’ classes at Oxford with the academic Roger Undy).

While it is generally accepted that this Labour frontbench is neither as dazzling nor potentially transformative as that of the first Blair government, they are starting to behave in a Blairite manner. One example is the newly appointed shadow spokesperson for technology and innovation, Peter Kyle, who is treading very carefully on the topic of AI.

At the recent Labour conference. Kyle and colleagues with similar remits, have been very careful to sound business friendly (emphasizing ‘progressive AI’) and the need for policy makers to permit ‘innovation’ in AI. His behaviour is not unlike that of Blairite politicians in 1997, who engaged with business before coming to power, and who worked hard to ‘not scare the horses’.

A Labour victory next year will quieten the British political landscape. It is likely that many of the badly behaved, ‘swivel-eyed loons’ – to use David Cameron’s term, of the hard right will either lose their seats or be relegated to the far fringes. Domestically, Labour’s greatest difficulty will be in the related challenges of restoring trend economic growth amidst weak public finances, and in replenishing investment in public goods like education.

Brexit will not be reversed, and neither will it be renegotiated under Labour, but there is scope for the EU and the UK to adopt a less antagonistic and more pragmatic stance with each other on trade oversight, financial services and the regulation of new technologies. Military and security cooperation might well grow even closer.

A Labour victory would mean that all of the large European economies have centre right or centre left governments, and that very few of them (even Italy) go against the grain of the European project. With Germany and France working on their relationship (over herring sandwiches in Hamburg recently) Europe will have the policy space to chip away at the many challenges it faces. 

Have a great week ahead

Mike

On Wednesday the EU Commissioner (Internal Market) Thierry Breton invoked the EU Digital Services Act to reprimand and investigate Elon Musk’s ‘X’ (Twitter) for the way in which it has quickly allowed disinformation and illegal content relating to the terror attack on Israel to spread. Elon Musk, the owner of ‘X’, in a clear mis-understanding of the EU’s rules, responded in an insouciant manner.

As the EU builds its case against Musk, the incident raises at least two issues. One is the increasingly central role of the EU in regulating the internet, data and AI, the other is the risk that the owners of these tools (like Musk) seem to care little for the harmful side-effects of social media, and that these negative effects could become more pronounced as AI grows in power and is further unleashed.

In that context, the race to establish the rules of the road for the use of AI acquires a new urgency, as does the need to frame a global code of conduct around these technologies.

In this respect, whilst not immediately intuitive to readers, I thought of early medieval history and especially to one of its authorities.

Those readers who are not familiar with the reading lists of medieval history might instead have read Frederick Forsyth’s book ‘The Negotiator’ (The Day of the Jackal is better known) in which they may notice a quirky entry where the protagonist, a student at Oxford, is told to go up to Mr Keene’s study. This was Forsyth’s nod to a well-known Oxford figure called Maurice Keen, the embodiment of the tweedy don, who held the seat of Professor of Medieval History (the prior holder as his father).

Maurice Keen’s great academic contribution was a book simply entitled ‘Chivalry’ which details the emergence of the chivalric code in the late 12^th century. One of the motivating factors behind the code (not dissimilar to the rules banning dueling six hundred years later) was the need to stop fatal disputes and attacks between knights (they were needed for the crusades), and to moderate the effect of their sometime arbitrary violence on medieval society as a whole.

Amongst the strands of the chivalric code were stipulations that knights should be generous, not lie and respect those weaker than them…elements that often appear lacking in the behaviour of the owner of ‘X’ and many of its users.

Thus, the reason for my discussing ‘Chivalry’ is an ongoing preoccupation with the various processes and attempts to build rules and frameworks to govern AI, and the corresponding search for benchmarks and heuristics. In the sense that it might illustrate how AI might not ‘do harm’, and be used in an honorable way, the chivalric code is not a bad place to start. This is especially so given that we are widely and frequently warned of the dangers of AI – to our jobs, media, politics and security to name a few domains.

The topic of the regulation of AI is perhaps the most significant institutional project of the day. At a point where globalization as we knew it is being left in the rear-view mirror of the world economic locomotive, the institutions that helped to frame the initial wave of globalization – the IMF, UN, WTO and World Bank are increasingly irrelevant or dysfunctional. The 21^st century will present new problems that will need to be marshalled by new technologies, and AI is the most prominent of these challenges.

In the race to frame and regulate AI, Europe has bolted ahead with its EU AI Act which delineates AI into four ‘risk’ segments. The US does not yet have a coherent AI regulatory framework and may find itself ‘reacting’ to what others are doing. China already has strict rules that govern the datasets and applications that AI can cover, though its framework is more ‘political’ than ethically driven. In this respect, Japan has become an interesting player.

Japan, as the last G7 host, is now running the Hiroshima AI process, a G7 template on ‘rules of the road’ for AI across the G7. Japan’s own AI strategy emphasizes several areas – global cooperation on the setting of standards, the need for Japan to invest in AI capabilities (proper data archival, engineering and innovation for instance) and a human values centric approach to the development and use of AI.

In that context, and in the absence of a formal AI code in the US, it is likely that an important axis for a common G7 approach is the Japan/EU relationship, as well as the work done by the OECD on AI. Here, EU Commissioner Vera Jourova, one of two commissioners (Breton is the other) has commented this week (at a conference on internet governance in Kyoto) that there is convergence between Japan and the EU on how they see AI ‘rules’, especially on generative AI. She also disclosed that a code of conduct for companies producing and using AI models was not ready.

The Jourova comments suggest that the wheels are turning on a G7 template on AI (to be released by year end) and that the European and Japanese approaches are important benchmarks, possibly to the detriment of the more limited UK approach.

A key point of discussion, notably from the Japanese side, is the competitiveness of their economy with respect to AI innovation, and this may be an element that carries through the debate with the EU.

It might be far too much to hope that European ‘chivalry’ and Japanese ‘bushido’ come together to contain the harmful effects of AI, but the lessons of history and the codes of other ages offer a steer as to how this might be done. So far, the actions of Mr Musk and others across the social media and AI sectors demonstrate a dangerous lack of ‘chivalry’.

Have a great week ahead, Mike

It is increasingly debated that the current generation of politicians, notably in the two Anglo-Saxon countries, are markedly inferior to those of prior generations – intellectually, morally and in their commitment to public service. Rory Stewart’s new book (Politics on the Edge) highlights a number of examples.

This is a view I have some sympathy for and a more compelling argument, supported by most politicians I have met, is that social media has debased politics and political debate, to the extent that the untrue and absurd garner greater attention from potential voters. Speeches at the Tory party conference last week (e.g. Penny Mordaunt) and the toppling of Kevin McCarthy by Matt Gaetz, are instances.

One of many litmus tests of this hypothesis is that the quality and quantity of pithy, quotable remarks by political leaders and policymakers appears to have diminished. Outside of set-piece speeches there seems to be far fewer impressively intelligent public utterances from those in public life. As a result, essay writers are left digging for lesser used quotes from Churchill with which to start their notes. This is a pity, not just for essay writers, but for the public at large.

Often, when those essay writers have exhausted the reservoir of Churchill quotes, they dip into Keynes. I recently happened upon a deep pool of quips from Keynes in Benn Steil’s ‘The Battle of Bretton Woods’, which is a superb account of the tussle between Britain and America to shape the new world financial order and with it, bodies like the IMF.

Tussle is too generous a word, the meeting effectively formalised the transfer of ‘world power’ from Britain to the US, or as Keynes wrote to his mother ‘ In another year’s time we shall have forfeited the claim we had staked out in the New World and in exchange this country will be mortgaged to America’.

Keynes’ prominent role at Bretton Woods was as foil to the American negotiator Harry Dexter White, and Keynes felt his place was to negotiate a deal for Britain that would rescue it from ‘losing face altogether and appearing to capitulate completely to dollar diplomacy.” For some, Keynes was living proof of Lord Halifax’ view that ‘they have all the money, and we have all the brains’.

From this point onwards, American financial dominance grew, manifested in the broad international use of its currency which has risen to a very particular place as the linchpin of the financial system. Indeed, one of the most important tenets of the twentieth-century  world order and the rise of globalization has been the position of the dollar as the international reserve currency.

This pre-eminence was christened in another memorable quote as ‘exorbitant privilege’ by Valery Giscard d’Estaing, then French finance minister and later President. When Giscard made this statement, the dollar was tied to gold, and the response from France and a number of other countries was to exchange their holdings of dollars for gold. This set the stage for the subsequent breaking of the dollar’s tie to gold by President Nixon. Since then, the dollar has been first among equals in the currency world, and many developing nations have pegged their currencies to it.

Recently, as we have noted before, this notion of ‘exorbitant privilege’ has come under scrutiny in the sense that there is a long line of commentators predicting the demise of the dollar.

A more interesting line of argument, thanks again to some French wizards (Pierre-Olivier Gourinchas and Hélène Rey) is the notion of ‘exorbitant duty’, which is the role that the dollar and US financial system play in times of crisis as the provider of a safe haven, even when those crises emanate from the US itself. As it stands, the next largest currency bloc to the dollar, the euro doesn’t have capital markets deep enough to become a fully fledged global safe haven. It might be that a group of smaller countries – Switzerland and Australia for instance could also draw in capital in a crisis.

So, the dollar may continue to do its duty, until perhaps it is undermined from within. While few in Washington will feel sorry for Kevin McCarthy, his removal represents another step towards the political unknown in America. Europeans and Asians are starting to worry about the prospect that Donald Trump could become president again and that the US might one day fail to do its ‘duty’.

Congress has got it wrong before. One of the comments in the Steil book recounts how after Bretton Woods ‘Congress was spontaneously more generous toward China than toward England, perhaps because no one envisaged China as a postwar rival for power or commerce.”