Everything is Fine

On September 16, 1992, the British pound was ejected from the rigid European Exchange Rate Mechanism (ERM) system that it had joined in 1990. In the ERM, the pound was linked to the Deutsche Mark but effectively at too high a valuation, making it uncompetitive. A few days later, Chancellor Norman Lamont tried to sound upbeat, telling journalists that ‘My wife said she had never heard me sing in my bath before,”, suggesting that he was happy to be rid of the ERM. This characteristic gaffe by Lamont was badly received at a time when British industry and households faced a sharp rise in interest rates.

The pound’s exit from the ERM came after painful interest rate hikes (from 10% to 15% in one day) and massive intervention from the Bank of England on one side of the foreign exchange market. On the other side, famously, was the speculator George Soros, who ‘broke the pound’ by selling billions of pounds in the expectation of a devaluation. At the time, a youngish Scott Bessent worked in Soros’ Quantum Fund. Today, as US Treasury Secretary, Bessent is having his ‘singing in the bath moment’.

Bessent has made two interventions in markets in the past month. The first, a historic joint move (the last one was in 1998) with the Japanese authorities to boost the yen. The involvement of the Treasury ensured that Japan was able to buy yen without selling Treasuries, which would have pushed US yields up. In that context, Bessent’s second intervention was a promise to effectively sell short duration bonds, and with the proceeds buy long duration ones, the intention being to push down long-term yields.

Bessent’s moves were greeted with puzzlement and some disdain in markets. Interventions in markets are rare, normally occuring when something is broken or about to break. When they do occur, they need to be large (almost unlimited) to have credibility. Mario Draghi’s announcement that the ECB ‘would do what it takes…and believe me it will be enough’ is the best example. Thus, the Treasury Secretary’s interventions give the impression that something is not quite right, and in this regard, at least three problematic issues are raised.

The first is that Bessent has announced the arrival of a debt crisis, or rather a debt purgatory, a long period where indebtedness weighs on government policy, markets, and geopolitics. The bond market intervention coincided with America’s debt burden topping the USD 40 trillion mark, and the Treasury Secretary has simply succeeded in drawing greater attention to this.

Markets registered this in May when long dated (30-year) bond yields on US, UK and Japanese debt hit levels not seen since before the global financial crisis. Bessent’s intervention shows that governments are now feeling the financial pain associated with this rise in yields and are starting to worry about how to curb it. A particular problem for the US, is that a mixture of geopolitics and AI driven debt issuance, mean that there are fewer natural or passive buyers of its debt.

The second element of note in Bessent’s actions is that they betray a philosophy across the Trump administration that is intensely focused on asset prices to the detriment of economic policy. The president’s active stock trading and public promotion of stock trades, billion-dollar forays into cryptocurrencies, and attempts to shepherd the oil price through social media are all part of this. At the same time, the US has a historically enormous budget deficit, which the rating agency Fitch expects to surpass 7%. In the past a deficit of such magnitude would only occur during a deep recession or financial crisis.

Today, in the context of a record high stock market, and an AI boom, it is a dangerous anomaly. Should something go wrong to pitch the US into a recession, there is no fiscal cushion. Bessent has done nothing to reduce the deficit and his tinkering in the bond market shows that the deficit is not his priority.

Thirdly, the bond market intervention is ill timed because the other ‘wing’ of American financial policy, the Federal Reserve, has a new chief, Kevin Warsh, also a former hedge fund manager. Warsh has a preference for a Fed that communicates less to markets, but he has so far not communicated well. Markets are unsure of his stance on inflation. The added complication is that Warsh prefers a more spartan Fed, one that is less active in bond markets, so the Treasury intervention is a contradiction of this. The other concern is that the Fed begins to suffer from fiscal dominance, which in simple terms means that in making policy, it is looking over its shoulder at the actions of the Treasury, and the sentiment in a wobbly bond market.

With markets still focused on AI, Bessent has unwittingly opened up a macro ‘battle’, which the bond market will surely win.

Have a great week ahead, Mike

Friends

An important sign that globalization is over and that America’s role as the keystone of the world order is crumbling is the flux in strategic alliances between countries, across multiple regions. Arguably there has not been a period of such furtive strategic alliance formation since before the Cold War. Globalization was a geopolitical anomaly in the sense that there were no major wars, international norms, rules of geopolitical behaviour and institutions were respected. This is certainly not the case today, and the idea of ‘fracturing’ we wrote about in 2020 is accelerating.

Sweden and Finland reacted to the invasion of Ukraine by joining NATO. Next week (29^th) Iceland will vote to recommence membership negotiations with the EU and potentially join Moldova and Ukraine in the accession queue. Iceland had toyed with membership in the aftermath of the global financial crisis and the consensus in the small country is once again turning to Europe, because of ‘geopolitics’, by which Icelanders mean the presence of Russia in the Arctic and greater Nordic region, and American threats to ‘take’ Greeenland.

The Iran War will eventually provoke a re-alignment of alliances across the region, where the crucial variable is the relationship between the UAE and Saudi Arabia. Two weeks ago, Saudi Arabia, Pakistan and Turkey signed a joint defense pact in Mecca, an accord that has strategic implications for Iran, Israel and notably, India. During the period of globalization, Turkish foreign policy was conditioned by the maxim ‘no trouble with neighbours’. Now, Turkey is involved in some form, in every skirmish in the region – from Libya, to Syria, to Azerbaijan to Iraq.

Then in Asia, relatively new ‘clubs’ have been forming; AUKUS (effectively a US – Australia alliance), the Quad (Japan, the US, India and Australia) and the Shanghai Cooperation Organisation (China, Russia and Pakistan are the main members). For their part, South Korea, Japan and Taiwan, all formal allies of the US, will be worried by the gradual strategic distance that the White House is putting between its Asian allies, the most recent is the curtailing of joint military training exercises between American and South Korean forces.

Most of these alliances are motivated by a common factor; an America that is more singular, and less willing to be the world’s policeman. This change is complicated by the fact that the White House appears to have a fascination for autocrats (for example, Steve Witkoff, President Trump’s peace emissary has not visited Ukraine, but is a frequent visitor to Moscow). Indeed, some of the critics of the White House’s foreign policy stance, such as Harvard academic Stephen Walt, go a step further and have referred to the US as a ‘predatory hegemon’.

The net effect is that many countries will now experience the loss of the ‘policeman premium’ they enjoyed when America underwrote their defence, and instead will have to pay a ‘predator premium’; the higher security and defence costs associated with a more adversarial geopolitical climate. Germany is the case in point, where military spending and combat readiness had dwindled during the period of globalizations, but where it has now lifted its debt brake and will spend up to Eur 1 trillion on defence in the coming ten years. Corporates are also facing this defence friction – either through supply chain disruption, cyber-attacks or the theft of corporate secrets to the extent that corporate intelligence is a fast-growing field (Lewis Sage-Passant’s book ‘Beyond States and Spies’ is a very good text here).

The kaleidoscopic shift in alliances will likely continue, and a cautionary tale is the manner in which the tangled web of alliances that sprung up during the first wave of globalization (1870-1913) tripped itself up. Then Europe was split between the Triple Alliance (Germany, Italy and Austria/Hungary) and the Triple Entente (Britain, France and Russia). Margaret MacMillan’s books on the First World War (for example ‘The War That Ended Peace’) are worth a read and the parallel in the arms race between Britain and Germany then, and China and the US now, is striking.

Alarmists might worry that a ‘great power’ war is close, but the only saving grace from the wars in Iran and Ukraine, is that the great military powers struggle to achieve their aims in the face of new technologies and tactics. Let’s hope they learn these lessons.

Have a great week ahead, Mike

Bezzle Bonds

In my summer reading note (‘A Good Read’) an important omission was a couple of books by the celebrated economist JK Galbraith, the ‘Affluent Society’ which is relevant to the many economies struggling with low growth (e.g. UK, Germany), and ‘The Great Crash’, a text that will surely come in handy in the next twelve months.

In this book, Galbraith introduces the term ‘bezzle’ by which he means the rise in fraudulent financial activity as an investment bubble gathers momentum. A slightly different version of this is the rise of what we might call ‘non-traditional’ or opaque forms of financing as the asset bubble gathers pace.

One nuance of the bezzle, is that there is a moment of suspended financial animation, where the investor in the ‘bezzle’ feels rich, thinks he/she is a financial genius and at the same time the bezzle premium starts to accrue to the architect of the ’bezzle’. Falling economic activity and asset prices bring home the truth of the ‘bezzle’ to the investor.

Last week’s note on the intense financialization of the South Korean stock market gave a taste of the giddiness that is building around the AI capital expenditure boom. In this context, investment products, such as leveraged exchange traded funds and ‘single-deal’ special purpose investment vehicles in IPOs like SpaceX are ‘bezzle-like’, and it might be argued that new AI startups that raise capital at a high valuation are also bezzles, if not simply hubristic.

Now, activity in the bond markets and private lending segment is beginning to acquire a ‘bezzle’ premium. For example, last week six of the largest banks and private equity houses announced the creation of a USD 500bn ‘pool of capital’ for Nvidia, to facilitate the buildout of its AI infrastructure. The details of the deal are complex to say the least. This financing package will be considered ‘off balance sheet’, so it won’t immediately show up in Nvidia’s balance sheet, but it will bind the financial and AI industries more closely together (note that a chapter in the Galbraith book has the ironic title ‘In Goldman, Sachs we trust’).

What is interesting is that bond markets are starting to react. Bonds issued by the large AI firms, or ‘hyperscalers’, are beginning to trade at a higher yield, reflecting the market view that they are increasingly risky. For instance, spreads on the index of hyperscaler bonds are now nearly double what they were at the start of the year, and it is much the same for credit default swaps.

This is important in at least two respects. First, it signals that individually some of the hyperscalers (META and Oracle are often mentioned) are running down their cashflow rapidly and building up debt just as quickly. Second, the corporate sector is becoming indebted again (from modest levels), under the spell of AI infrastructure build.

This is concerning as we look towards 2028 (when in my view the AI capital expenditure boom judders to a halt) because public debt levels are already considerable, in fact they have never been higher across the major economies. To that end, public debt markets are also beginning to price in a riskier outlook (long dated bond yields in the UK, South Korea, Japan and the US are at or close to multi-decade highs). Rising real yields (inflation adjusted) tend to be a more cautious signal for markets. Equity markets appear not to notice, or care, but other asset classes like foreign exchange are also signalling trouble in the engine room (the joint US-Japanese intervention in the yen was a case in point).

The net economic effect is a sort of balance sheet ‘bezzle’, to stretch the analogy. In the US, households have never been more exposed to the equity market, and its rise is producing a marked wealth effect. Based on long run valuations, this wealth effect may be close to peaking though the psychic wealth effect remains strong. On the other side of the balance sheet, government debt continues to grow – one third of all the debt that has been issued by the US has come during the Trump administrations, and corporate debt is edging up as AI infrastructure spending gathers steam.

Have a great week ahead, Mike

KOSPI Chaos

Apocalyptic stories are emerging of how retail investors in South Korea have made, and then quickly destroyed fortunes in the country’s stock market boom and bust and, we may soon learn that institutional investors, trading firms and banks have been damaged by the fallout. Korea’s Kospi index, which more than doubled from the end of 2025 to its mid-June peak, has collapsed by over 40% since then, with a one-day bounce of 18% at the end of last week.

The index has become an economic absurdity and its volatility (VKOSPI index) is greater than during any of the financial and economic crises of the past thirty years, the Asian crisis of the late 1990s included. There will be considerable damage to the South Korean economy, but so far, unlike the Asian crisis, there is relatively modest contagion across other markets (despite South Korea having rocketed into the top six equity markets in the world).

The absence of broad contagion is not an ‘all clear’ signal. Rather, South Korea is the latest, lurid event in an epidemic of speculation across the world, that is built on the financialization of real economy companies, assets and technologies. While South Korea’s largest technology firms, Samsung and SK Hynix, have become key elements in the AI supply chain thematic (specifically for computer memory), their performance has been wildly exaggerated by financial engineering.

Brokers have created leveraged single stock exchange traded funds on these firms and others, and in recent weeks, trading volume in these financial products has outstripped volume in the underlying stocks by a factor of four times. Option trading volume in Korea has exploded, as has the creation of warrants and structured products, again based largely on the memory stocks. Now, some 3x leveraged Exchange Traded Funds (ETFs) are down between 80 to 95% from their recent peaks. Of course, the majority of trading activity has come from retail investors in Korea, many of whom have used margin debt.

This might all be a bit of emerging market fun were it not for the fact that South Korea is emblematic of the global investment ecosystem, which is driven by the logic of AI capital expenditure but built on the increasingly wobbly foundation of financial engineering. As an illustration, LongView Economics, the independent strategy house, has constructed a ‘Speculative Fervour Index’, based on leveraged ETF activity, and it has risen sharply in the past year, coinciding with an all-time high in US household ownership of equities.

From that vantage point there are at least three serious policy concerns for the US and for American retail investors, if they choose to listen.

The first is a repeated transfer of risk from institutions to retail investors. Semiconductors was just the latest episode, following the SpaceX IPO and the rise and fall of silver and gold earlier this year. The day retail investors stop believing they can beat the market, they will be furious. US households have never owned more equities, wealth per adult has never been as high in America, and wealth inequality in the US is straining historical comparisons. Repeated shocks to households will soon have economic and political effects.

The second effect is the relation between investment and the economy. In an era where Carlota Perez’s (author of ‘Technological Revolutions and Financial Capital’) concept of ‘production capital’ is gaining traction, and where the rebuilding of industrial capacity in the US and EU is a necessity, the risk is that financially engineered investment instruments squander capital and misdirect it from economically meaningful investment projects. High stock market valuations may convince politicians that everyone is getting rich, but there is a serial misallocation of capital occurring before them.

This leads to my third point, which is the role of policy makers, central bankers and regulators. It used to be the case that market stability was a concern for regulators and central bankers, the South Korean authorities have been late to the scene of the fire. In the increasingly ‘regulation-lite’ environment of Wall St., the dominance of financial engineering (there are more ETFs than stocks now and option trading volumes continue to surge), the risk of sporadic volatility events, and, at some stage, a much greater unwind. It should also be a concern for Kevin Warsh, and this is just one topic he needs to be more forthright on.

For their part, US investors have carried on where the Koreans have left off. In the past three trading sessions, options trading volumes have spiked, driving equities higher. A volatility ‘event’ may not be far off.

Have a great week ahead, Mike

A Good Read

An emerging trend in our screen driven societies is that fewer people are reading books. A YouGov poll found that 40% of Americans did not read a book in 2025, though nearly all of them consumed streaming services and social media. Other studies, from the National Endowment for the Arts and Bureau of Labor Statistics highlight that younger generations read less, and a number of studies (such as the Programme for International Student Assessment (PISA) attainment scores) show that reading proficiency in many high-income countries is declining. Worse still, AI is taking over writing, to the extent that the FT ran a headline last week ‘The new premium product: books written by people’

A counterargument is that people are consuming fiction and non-fiction in different forms (such as audio books) but, in my view, it’s just not the same. Reading involves consuming ideas with the ‘brain-on’, and by not reading we miss out, not only on great tales, but the lessons of history, human behaviour and the world we live in.

However, I know that most of my readers love books, and as I head off on holiday, I want to recommend a few titles. I divided these into two categories, the books I ought to have read (non-fiction), and the books I really wanted to read (fiction). In that spirit, I packed my bag with a couple of serious books, but once I settled into the hotel, I found a cheap thriller written in 2006 that I read instead.

Starting with the serious books, I packed ‘Twilight of the Dons’ by Colin Kidd, not a text that will grace many beaches I imagine. The book recounts a period when academics had a much more vaunted position in British public life (it was said that the motorway from London to Oxford was built so that ministers could leave Westminster in the evening to dine at All Soul’s College).

The book bolsters the view that one of the reasons for the crisis that Britain finds itself in is the desiccation of education and learning, in terms of the devaluation of the idea of education as a public good, diminished funding from the state and the strange preference for overseas students over British ones in the best schools and universities. I had a vague hope that Andy Burnham, the first Cambridge educated prime minister (a student of Literature) might encourage a more learned approach to government, even if his first week in office leaves me lukewarm.

Then, the book I am really looking forward to reading is ‘1873’, by Liaquat Ahamed. His first book ‘Lords of Finance’ related the emergence of central banking in the US and Europe in the 1930’s and is one of the best economics books I have read, and a work that was clearly written with great passion.

‘1873’ relates the events around the market panic and financial crisis of 1873, a period of ‘true capitalism’ in the sense that then there were few of the policy guardrails we have today. Apart from Ahamed’s writing, the book is relevant today for its detail on the railway investment boom, and the subsequent deep recession that followed the Panic of 1873. In that context, there is an alarming rise in books whose titles recount financial collapse, another one is Andrew Ross Sorkin’s ‘1929’ which is rich in detail on the social and political context of the 1929 crash.

To finish my economics recommendations, another question that besets commentators and investors is the future of the dollar. In 1976, the economist Charles Kindleberger declared ‘The dollar is finished as an international money, but there is no clear successor’. This view is largely correct, but the prospect that America’s power is diminishing, may have consequences for the dollar, and there is a flurry of new books on the role of the dollar, of which books by Barry Eichengreen (Money beyond Borders), Ken Rogoff (Our Dollar, Your Problem) and Paul Blustein (King Dollar) are prominent.

One book I have mentioned in recent notes, and that I reiterate is Giuliano da Empoli’s ‘The Hour of the Predator’, which succeeds in capturing the spirit of our political times. We have moved from a period of democracy and technocratic engagement between nations, to a lawless one, dominated by autocrats and oligarchs, who vandalise laws, norms and institutions under the false premise of enacting change. The principal lesson today is that centrist politicians, Keir Starmer was the example, need to stop becoming ‘prey’ and change their tactics.

Then, more specifically on AI, last week I wrote on the speed at which the sector is evolving and find it hard to recommend books that can keep pace with this (the best source I have is Azeem Azhar’s Exponential World blog). So, I fall back on Carlota Perez’ framework in ‘Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages’. Another useful book in this context is Johan Norberg’s ‘Peak Human’ which describes the emergence of empires, their deployment of technology and sketches the lessons for our world.

Now, with the holidays really in mind, I jump to non-fiction. One of the best books I have enjoyed this year is Alex Starritt’s ‘Drayton and Mckenzie’ is an absorbing story of two entrepreneurs, written in a stylish, mischievous way that does an excellent job of capturing the prevailing economic trends of the past twenty years.

Also, some of my favourite writers have released new books in the past year – William Boyd’s second, amusing Gabriel Dax story ‘The Predicament’ (with ‘Cold Sunset’ out in September), and Ian McEwan’s ‘What We Can Know’. I’ve just read the first of John Banville’s ‘Quirke’ series (Christine Falls) and recommend it, together with the latest in the series ‘The Drowned’ and ‘The Lock Up’. If readers are looking for classics, I propose Bram Stoker’s ‘Dracula’ for a summertime scare.

In the realm of thrillers, an entertaining, new writer I have come across is David McCloskey, a former CIA analyst, co-presenter of the fun podcast ‘The Rest is Classified’, and already author of four espionage thrillers, the latest of which ‘The Persian’ I recommend.

I’ve just finished reading Nick Fox Weber’s book ‘The Art of Tennis’, which is remarkable for the quality of his writing and the breadth of his knowledge of sport, American society and art. It set my mind searching for comparable writers on sport, and the one who comes to mind is the late David Halberstam, I loved his book ‘The Amateurs’.

Enjoy, Mike