The Debtor’s Prison

Although I devoted last week’s note to book recommendations, I want to start this week’s missive by also highlighting a few classic works, notably Charles Dickens’ ‘Little Dorrit’ and Honoré de Balzac’s ‘Lost Illusions’ and ‘Pére Goriot’. All three books, published in the middle of the 19^th century, in the shadow of the debt burdens that resulted from the Napoleonic Wars, speak to the pernicious aspects of debt – debtors prisons, debt collection and the surrender of properties caused by over-indebtedness.

They have come to mind because markets are beginning to price in a potentially very dramatic change in fortunes – which, if it occurs, will be historic and far reaching. There are at least three noteworthy elements to this.

The first is that the difference between interest rates for companies, relative to ‘safe’ government bonds, have fallen to historic lows. In more technical terms, corporate bond spreads (corporate yields less the US 10 year bond yield for example) and spreads for riskier high yield bonds in the US, are now well below long-term average levels. While this is a function of strong risk appetite and demand for fixed income, it is also a recognition by markets that debt levels for corporations (on average) are at very manageable levels, while those for governments are not.

Second, the spread between emerging market debt (countries and companies) and Treasuries has also compressed, to multi-decade lows. Again, this is an indication of appetite for yield from investors, but also a re-evaluation of the riskiness of emerging market debt (compared to countries like the US). Emerging markets collectively (China skews the data) have a debt to GDP ratio of 75% according to the April edition of the IMF Fiscal Monitor, which is the highest it has ever been.

The only saving grace is that emerging economies have lower debt levels than the developed world, though the threshold to debt sustainability is much lower for emerging economies (less deep markets, harder to gather taxes). What is more interesting is that within the emerging markets universe there is a decent number of large emerging economies that have relatively low levels of debt – Indonesia and Mexico for example.

Then third, rising stock markets and property markets, not to mention business creation, have created massive wealth. Remarkably, world wealth stands at over USD 500 trn, with nearly half of this in the USA where the wealth of the average adult is USD 620,000, according to the recent UBS wealth report. The USA is also home to about 60% of the world’s ultra-high net worth individuals, those with net wealth of over USD 50 mn. Surpassing this group, there are close to 3,000 individuals globally with wealth between USD 1bn and USD 50bn (collectively they are worth nearly USD 13 trn).

The point of sketching out varying levels of debt and wealth is that in the next five or more years, there will be a seismic transfer of power, influence and wealth between those who have ‘healthy’ balance sheets, and those who are encumbered with debt…as Dickens and Balzac have so skillfully demonstrated.

To give a few examples. The UK is notoriously fiscally constrained and cannot alone raise the capital to fund its ambitious AI Opportunity plan. As such, it will likely enter in partnerships with sovereign wealth type investment funds (Caisse des Dêpots, the Canadian fund, has just announced a CA$ 3.5bn investment in a nuclear energy plant in Suffolk).

The same is true in the US. In a recent research note, Morgan Stanley estimates that the US will need to invest USD 3.5 trillion in AI infrastructure up to 2028 (new energy sources and data centres), and that at least half of that capital will come from the large technology firms in the US. In the context of America’s fiscal constraints, cash rich technology firms will become more powerful, and critical to national

If the US has a debt crisis, and Treasury yields balloon out beyond 8%, an easy political remedy would be to co-opt (under threat of a punitive wealth tax) America’s wealthy to buy government debt. Equally, sovereign wealth funds of low debt countries like Norway, will have a unique opportunity to buy strategic assets across Europe in the event of a debt crunch.

My prediction is that France, the UK and perhaps the US will spend the next fifteen years in the ‘Debtor’s Prison’, while lower debt countries like Germany, Poland and the Netherlands and Norway will enjoy a strategic opportunity. In a world where democracy is under pressure, and in some cases inequality is rising, large cash rich companies will control more strategic assets, and the wealthy will find that governments need to court them rather than tax them.

The one country where this may not be the case is China, which is vastly indebted. Having studied the way some European economies become heavily indebted in the aftermath of the euro-zone crisis, the Communist party will throw entrepreneurs, the wealthy and corporates into the Debtors Prison, and let them pay their way out.

Have a great week ahead,

Mike

A Good Read

With the holiday season approaching I am putting together a new set of recommendations – along three criteria – books on finance, books that help us to understand the changing world and to take readers minds off this changing world, enjoyable fiction.

To start with finance and economics, Ireland is unusual internationally in terms of its budget surplus, other countries are in a much tougher place. In particular, Britain’s Chancellor Rachel Reeves has had a difficult year, granted the backdrop of a high deficit and heavy debt burden. It is a difficult job, as evidenced by Reggie Maudling’s letter to his successor in 1964 ‘Sorry to leave it in such a mess, old cock’. In this respect, Roy Jenkins book ‘The Chancellors’ is worth dusting off, and few other books by finance ministers are as analytical (Tim Geithner’s ‘Stress Test’ and Ben Bernanke’s Courage to Act’ were fairly dull). However, the other book in this realm that I recommend, with Fed chief Jerome Powell under pressure from the White House, is Liaquat Ahmed’s ‘Lords of Finance’.

With some markets creaking nervously (bonds) and others behaving complacently (equities), it is time to re-read Roger Lowenstein’s ‘When Genius Failed’ the story of the collapse of the LTCM hedge fund. I recall a seminar where David Modest, a partner in LTCM recounted, with some emotion how it came asunder. Another classic, from before the LTCM era, but that is relevant to private assets, is ‘Barbarians at the Gate’ by Bryan Burroughs and John Helyar.

Then, if the summer weather is too hot, it’s always good to have a few trophy books lying around, that will certainly never be read, but nonetheless confer an aura of wisdom on their owners, such as ‘A History of Interest Rates’ by Sydney Homer and Richard Sylla.

Moving on to books that will help steer readers through intense geopolitical change, I want to start with the late Joe Nye’s ‘Soft Power’ and ‘Life in the American Century’, which give a now nostalgic glimpse of a more internationalist America. Two pre-occupations in Washington are defence, and wealth. On the former, Alex Karp’s ‘Tech Republic’ was more thoughtful than I had expected, and the two futuristic books on the defence threats that the US faces, by Admiral Jim Stavridis and Elliott Ackermann ‘2034’ and ‘2054’, give us a sense of how conflicts of the future will be fought, even if these books are being overtaken by events.

Then, with the recent Trump budget (Big, Beautiful Bill) set to tilt the economic scales in favour of the wealthy, Evan Osnos’ book ‘The Haves and Have-Yachts’ is worth a read, as are Oliver Bullough’s books ‘MoneyLand’ and ‘Butler to the World’ on the topic of wealth and corruption.

Universities have been in the news this year, and ironically, there are very few good books about university life. In a previous note I had recommended Tom Sharpe’s ‘Porterhouse Blue’, and would add Lucky Jim by Kingsley Amis, Changing Places by David Lodge and for fans of university sports, the classic ‘True Blue’ by Dan Topolski.

Switching continents and genre to fiction, a few works of fiction are worth reading to help shape our view of Russia (and Ukraine), most notably Vasily Grossman’s ‘Everything Flows’ and Mikhail Bulgakov’s ‘White Guard, and then more generally Pushkin’s Eugene Onegin (decent as an audio-book on a long journey).

For well written fiction, I think William Boyd’s writing is superb (his latest book is Gabriel’s Moon), Shuggie McBain by Douglas Stuart is an example of very original, inventive use of English, and for those readers who can’t escape finance, Lionel Shriver’s ‘The Mandibles’ gives a glimpse of how it might be to live in a financially broken world. Sentimentally, I wanted to also mention Edna O’Brien, who died this time last year – have a read of ‘Country Girls’.

As a last word, I am taking a collection of very different books with me this summer – a friend has kindly given me a copy of Ed Luce’s ‘Zbig: The Life of Zbigniew Brzezinski’, which I look forward to not only for colour on one of America’s great strategists, but I expect for Luce’s generally excellent writing.

I would also like to read ‘Kingmaker’, Sonia Purnell’s account of the life of Pamela Harriman, former US ambassador to Paris, amongst many other roles. In addition, in a world of ‘deal-making’ I am packing the ancient, François de Caillière’ ‘L’Art de négocier sous Louis XIV’ and the ‘Letters of JRR Tolkien’.

Have a great week ahead,

Mike

Bushido

One of the favourite books I have received as a gift is ‘Bushido’, the framework of the Japanese code of chivalry. I was given the book in the very early 2000’s, when it was not yet obvious that Japan would stagnate for quite so long and, the talk was still of the collapse in Japanese golf club membership prices

Indeed, one of the remarkable socio-economic trends in Japan up to the mid-1990’s was the startling rise in Japanese gold club membership fees, which in the heady 1980’s Japan, had become a tradeable asset, so much so that an index was created (always a warning sign). During the period 1982-1989 the average golf club membership fee rose by 400%, with a final 190% spurt from 1989 to 1990. Companies such as Ginza Golf Services initially made a lot of money trading golf club memberships and at the peak of the market some were changing hands for close to USD 3mn.

Naturally, this bubble collapsed, and as a nod to the future I flag a blogpost from ‘GolfProp’ magazine that shows that on average entry fees for American gold club memberships have been increasing at a rate of 23% per annum since 2019. Indeed, within the past year the membership fee at Mar-a-Lago has gone up by 43%

Back to Bushido, which as a noble, chivalric code developed in the 16^th century, is unlike European ‘Chivalry’ (see Maurice Keen’s book of this title is a must read) in that the idea of ‘Chivalry’ came about much earlier, and largely because of an effort to stop the knights of Europe killing each other in jousts and disputes. Bushido is still part of the mindset of many Japanese, and Japan is increasingly unique as a country where very strong social codes frame behaviour.

To that end, the sense of bushido and Japanese diplomacy will have been taken aback by the unexpected decision by President Trump’s to slap a 25% tariff on America’s main allies in Asia, Japan and South Korea. Japan has always enjoyed close ties to the US (Al Alletzhauser’s 1990 book ‘House of Nomura’ is a very good account of how America helped build the modern Japanese financial and corporate system). I have a sense that another book of that era, Ezra Vogel’s ‘Japan as Number One’, seems to have stuck in Trump’s mind (in the 1990’s he went on CNN to castigate Japan American foreign and trade policy on Japan).

Trump and ‘bushido’ are anathema to each other, and the Japanese will be disappointed by his behaviour, given that Tokyo has always had close relationships with American presidents – though never as close as that with Jacques Chirac who visited Japan over 40 times (for various reasons which I shall not disclose).

The potential rupture in relations between Tokyo and Washington introduces a strategic dilemma for Japan, at a time when its economy is awakening from decades of slumber. Like the UK, Japan’s geopolitical moorings are coming unstuck. President Macron’s state visit to London shows the direction of travel for the UK on security and defence, and whilst it is accelerating defence spending, Japan may end up considering more radical solutions for its defence in the context of Chinese belligerence (in 2024 Japan’s air force scrambled jets 704 times against incursions by Chinese and Russian jets). For instance, Japan is the one country that could quickly build a nuclear weapons programme, if it needed to.

What is interesting in the Japanese case is that as geopolitical uncertainty rises, its economy and financial markets are thawing. The property sector is just reaching levels last seen in the early 1990’s (while Tokyo prices have recovered beyond 1991 levels, the rest of the Japan’s residential market is still below the price point reached then).

Having suppressed bonds yields for a long time, the Bank of Japan is now raising rates, and Japanese bond yields have been pushing higher, and given the size of the Japanese bond market (and the balance sheet of the Bank of Japan), it is driving yields higher internationally, and deserves watching as a medium-term risk to markets.

However, while bond yields are rising in the absence of yield curve control by the central bank, factors that are regarded as engines of the economy – earnings, consumer behaviour and employment are more muted, and give rise to the sense that Japan is either in the ante chamber of a full recovery, or on the precipice of something nastier.

Tariffs, and a confusing break with the US, could upset the Shigeru Ishiba’s unpopular government (Upper House elections are soon), which is struggling in the context of a very ‘un-bushido’ world.

Have a great week ahead,

Mike

Guns and Roses

It looks like I will have to burn all the Biggles books I collected as a child and jettison any antique copies of ‘Eagle’ comic books, because there are reports that Britain and Germany are about to sign a defence co-operation agreement, ending a long stretch of history where they have been on opposing sides. Indeed, the entire literature of what George Orwell described in his essay ‘Boys’ Weeklies’ could now be caught offside.

For instance, the work of John Buchan, once Governor General of Canada, and well known as the author of the ‘Thirty Nine Steps’, may be especially dislodged by an agreement that casts Germany and Britain as best geopolitical friends, as many of his books, like those of Captain W.E. John, depend on the role of the indispensable British hero seeing off his German nemesis. An innovation on the part of Buchan, was the glamorous female mastermind, Hilda von Einem, who vies with the handsome Irish intriguer Dominic Medina (please do read ‘Greenmantle’ and the ‘Three Hostages’) as the foil to Richard Hannay.

One of the significant moments of history when Britain and Germany (Prussia then) found themselves on the same side was the Battle of Waterloo, one of the great contests, where during a pounding from French guns Wellington’s officers asked for orders he replied, ‘there are no orders, except to stand firm to the last man’.

One of the survivors was Henry Percy, aide de camp to Wellington, who after the Battle had to row halfway across the Channel with the news of the Duke’s victory, as an absence of wind had halted his sloop. On arriving in England he found that many (in the City) already knew of the victory owing, allegedly, to a network of agents assembled by Nathaniel Rothschild who is said to have made a fortune on the event and thereby spawned the phrase ‘buy on the sound of cannons’. It is a useful illustration of the roles of communications (social media today) and finance in war.

Indeed, part of the reason that Germany and Britain are moving closer together on defence (France is even closer to each one militarily) is finance. Gone are the days when London and Berlin could afford to spend 9% of GDP building great battleships in the lead-up to the First World War (Margaret MacMillan’s ‘The War That Ended Peace’ is worth a read), and now they must do with more meagre ambitions and newfound collaborations.

In this context, the recent NATO Summit was a watershed as it signalled a headline commitment to 5% defence spending across NATO countries (as a % of GDP), something that would have been unthinkable four years ago.

In Europe, there is a sense that some of the defence spending pledges amount to a ‘fudge’, and it is very clear that defence spending as a % of GDP does not translate into defence readiness. Of the European members of NATO, the UK, Greece, France, Poland, the Nordics and Baltics are the most defence ready, and some of them are already spending ambitiously. For example, Poland is set to reach a level of defence spending of 4% of GDP and has already struck a strategic military procurement partnership with South Korea.

On the other hand, countries like Italy and especially Spain have been castigated for their reluctance to spend. Italy has talked of including investment in a bridge from the mainland to Sicily as defence infrastructure and in the case of Spain, it has apparently tried to ‘kitchen sink’ other tangential forms of spending into the defence segment.

Still, the broad 5% target is a gamechanger, and is comprised of two parts – close to 3.5% on defence spending and then 1.5% on areas like cyber security and AI driven defence capabilities. Momentum will be boosted by the EU’s Eur 150 bn lending facility for defence procurement, up to Eur 3bn in loans from the EIB (European Investment Bank), and the German government’s significant augmentation of its defence budget. Still, this fiscal support leaves an enormous shortfall that will likely require capital from the private sector.

In this respect, we are at the cross-over of geopolitical forces. NATO as an operating construct has been thrown into doubt by Donald Trump and the actions of his defence policymakers (the latest act being to deprive Ukraine of defensive missiles). As such, Article 5 no longer seems as watertight as it did in the early 2000’s (it has only been invoked once, in September 2011, by Nick Burns, then US Ambassador to NATO). The impression many in Brussels have is that Europe will be left to defend itself from Russian aggression – there is now a parlour game amongst the various European intelligence agencies to estimate when a Russian incursion might occur.

As a result, the EU will become a much bigger player in defence procurement (see the recent White Paper here), Europe’s defence centric innovation economy will grow rapidly, and ‘war bonds’ will become a new asset for investors. Europe’s main threat is most obviously Russia, in addition to cyberwar from further afield. The danger in the long-term is that it finds itself as the last bastion of democracy, amidst a range of large, autocratic countries.

To return to Germany and Britain, anyone who reads the MacMillan books can’t escape the recognition that the arms race between Germany and Britain over one hundred years ago, is now being repeated by the US and China. Ultimately Europe may count itself lucky to stay out of this context.

Have a great week ahead,

Mike

From Tea Party to No Party

The performative exchange of military strikes between Iran and the US means that a nuclear tipped hot war in the Middle East is off the cards for the moment, though the bad news is that a far greater crisis awaits.

In the past five or so weeks prominent financiers – Ray Dalio, Jamie Dimon and even Elon Musk – have warned about the burgeoning fiscal deficit and the mountain of debt that the US (and other countries) has accumulated. A very decent blog post by Indermit Gill, the chief economist at the World Bank, outlines the viewpoint.

Next week, there is a good chance that the Senate passes President Trump’s budget, which according to the independent Congressional Budget Office (CBO) will swell the deficit by close to USD 3trn and push debt to GDP towards an unprecedented 125% in the next ten years Additionally, rumours that the next Federal Reserve chair will be picked soon by President Trump (Powell leaves in May 2026) has upset the dollar, making life even more difficult for foreign holders of US debt.

What is interesting is not how gargantuan the world’s debt load has become, but how few people care. Politics in the West has changed so much that it has neutered what used to be a political class who in a very Catholic way, pronounced themselves to be fiscally responsible.

In the US, it used to be the case that a good number of Senators were what was called ‘fiscal hawks’, or had an aversion to large budget deficits, and an even greater aversion to resolving them through higher taxes (the US has only produced budget surplus twice – under Lyndon Johnson and then Bill Clinton – and in both cases taxes were raised). Paul Krugman has referred to deficit hawks as ‘deficit scolds’, because the spend more time warning about the dangers of the deficit than fixing it.

Ronald Reagan, and the policy makers who surrounded him – namely James Baker, Nicholas Brady and Don Reagan, were fiscally conservative by reputation but had the luxury of being able to grow the US economy through tax cuts and de-regulation. At the time (early 1980’s onwards) some Republicans had a ‘starve the beast’ mindset, which is to say that they favoured lowering taxes so that the government would have less revenue to spend, but there is little evidence that this worked as a strategy (partly because many of the initial Reagan tax cuts were aimed at the rich).

In the post Reagan phase, deficit reduction as a virtue came into its own in the Robert Rubin era (at the Treasury), and many of his former colleagues and acolytes continued this during the early years of the Obama presidency (a relevant private body is the Hamilton Project, where Rubin was a founder).

One of the notable initiatives of the Obama White House was the creation of the US National Committee on National Fiscal Responsibility and Reform or the Simpson-Bowles Commission as it became known, a bi-partisan body that aimed to reduce the fiscal deficit and debt. Its most noteworthy aspect, in my memory, was the degree of civility and collaboration between representatives of the Democrats and Republicans. Such a body could not exist today.

Indeed, the radicalisation of parts of both parties, in the context of quantitative easing (which has dulled the impact of rising debt and deficits) has broken the link between fiscal responsibility and electability. For example, the first crack in the Republican edifice was the advent of the Tea Party Movement, one of whose tenets was tough fiscal responsibility, as inspired by a ‘Chicago Tea Party’ rant from CNBC commentator Rick Santelli in 2009. Many of the Tea Party oriented voters and Republican politicians then gravitated to the Trump corner in 2016, the price of which was a surrender of their fiscal sacred cows.

Today there is only a handful of fiscally conservative Republican Senators (the Club for Growth publishes an annual scorecard of how fiscally rigorous it thinks members of the House and Senate are). The majority of Republican Senators appear happy to give the nod to a policy that edges the US closer to the financial precipice. Indeed, not only will the Trump budget favour wealthy households but it will increase the number of financially precarious households, and damage healthcare and education provision.

The other interesting observation I draw is that the relationship between debt and politics has now reached a turning point, and from here debt will condition politics. I see this happening in at least three ways.

The first is that in the context of ‘zero fiscal space’ the constraints imposed by high levels of debt and deficits, will drive new splits within parties, for example between those who are keen to spend more on defence, versus those who wish to preserve social welfare safety nets. The revolt by a large number of Labour MPs against benefit cuts imposed by Keir Starmer is an example. In the future, this cleavage may inspire new political parties. To echo a recent note (The Power Algorithm) new ‘tech bro’ parties could materialise that prefer using robots to do the work of immigrants and that technology should be deployed for social control.

The second, related scenario is that in the absence of money to spend, the traditional ‘pork barrel’ cycle of politics disintegrates, and instead politicians tilt the broad political debate to non-fiscal issues – identity, foreign policy, and immigration.

A third element in the hypothesis is that voters observe mainstream politicians to be helpless and useless in the face of very high fiscal constraints, and they become largely apathetic about politics and in some cases vote for extreme candidates, such as ‘chainsaw economists’ as in the case of Argentina.

In this way, and perhaps exceptionally in history, the coming debt crisis (if the World Bank’s economist is correct) will be intertwined with the current crisis of politics.

Have a great week ahead,

Mike