Much of last week was spent in Rome, which is overwhelming in its sights, though the highlight for me was the peace of the Appian Way. Rome is also rich in lessons on civilisation, politics and strategy – many of which appear to be lost on leaders today. In that respect it is a good place to consider the rise and fall of nations, a phenomenon that is gathering pace.

More broadly if we consider the biggest, most powerful cities in the history of the world, Rome stands out. Many of these great cities— Babylon, Nimrud (south of Mosul), and Alexandria—were the focal points of great civilizations but, sadly, have been in the news for the wrong reasons. It is surprising how many Chinese cities have been “the biggest” through time, with cities like Nanjing, Xi’an, Hangzhou, and Beijing dominating the period from AD 600 to AD 1800. London briefly took over during the nineteenth century, and the biggest-city baton was then passed to New York.

Overall, if we adjust for world population and perhaps level of development, Rome has a very good chance of being considered the world’s greatest city. At the time of the birth of Christ, Rome had one million inhabitants. Scaling for demographics, Tokyo, to match this, would need to have over seventy million residents today. Rome is also impressive in that it was the world’s dominant city for some five hundred years.

Yet, the empire it spawned (which endured for twice the typical 240 year lifespan of empires historically) is today often used as a template for the potential decline of America (or, together with the example of ancient Greece – the rise of China against the relative decline of America).

This in turn should lead us to think of Edward Gibbon’s The History of the Decline and Fall of the Roman Empire, which is a reference point in economic history in general and in declinism specifically. Gibbon sought to explain why the Roman Empire disintegrated. His thesis is that Rome became complacent, its institutions were weakened, and the leaders in Roman public life lost their sense of civic virtue, or what Niccolo Machiavelli later simply called “virtu”—the good of the republic or common good.

Since Gibbon, other writers have turned declinism into a deep furrow. Germany’s Oswald Spengler controversially wrote The Decline  of the West in 1918, and in recent years in Europe we have had Thilo Sarrazin’s book Deutschland schafft sich ab (Germany gets rid of itself ), followed by books like Eric Zemmour’s Le Suicide Français and Michel Houellebecq’s Soumission, not to mention a raft of similar titles in the US.

Many of these books are impatient, and make the mistake of thinking an ‘empire’ ends with an event whereas in reality it is more of a slow process, the economic signs of which may be a failure to enhance productivity, falling human development and a failure to keep up with new technologies.

Yet, if the history of Rome and Gibbons’ assessment of it in particular are a guide to the runners and riders in today’s multipolar world then what else should we look out for?

To start with I would watch out for a breakdown in ‘fraternity’ or social cohesion as characterised by for example a rise in inequality. In the USA wealth and income inequality are close to the extremes of the 1920’s. The share of income of the top 1 percent is now back to levels not seen since the 1920s. In New York, the ratio of the  income of the top 1 percent to that of the other 99 percent is 45 to 1. A good portion of this gap is driven by high executive pay, which across the range of industries in the United States averages three hundred times the pay of the average worker. It is hard to find such an extreme relationship at any other time in history. In Rome in AD 14, for instance, the income of a Roman senator was one hundred times the average income, and legion commanders received an income of forty-five times the average!

A second is political agitation, which is manifest in many countries. My personal, very amateur view is that political systems that allow themselves to change and evolve, will avoid extreme outcomes. The disappearance of old political parties and the rise of new parties and a new ‘centre’ in France and Germany are examples. In contrast the lack of flexibility of two party systems in the UK and US has produced extreme political outcomes.

Perhaps a more pertinent argument would be to relate ‘strong man’ governments to the Roman system – where the increasing concentration of power around one man (Russia, China) could produce a catastrophic strategic error. In that regard, whilst the declinists focus their attention on the US, it is worth spending more time thinking about China.

The dominant size of Chinese cities from the period 600 to 1600 AD should at least inform those outside China that the China Dream is based on a desire to reclaim its historic role as an economic superpower and, to date its economic decision making has been very good. To that end, China has a new, economic empire. It is yet an unsure geopolitical player with few allies in Asia and the wrong ones (Russia) further afield.

Its most fragile aspect is the concentration of power around Xi Jinping, which will be tested by China’s coronavirus crisis and by the socio-political effects of slowing growth and demographics. He should bear in mind that for all the years the Roman Empire endured, the average ‘term’ of a Roman emperor was only just over five years, seventy percent of them dying of ‘unnatural’ causes.

Have a great week ahead,

Mike

Henry Parker Willis was an understated, underestimated though very important figure in central banking. An academic and expert in finance, he was a key architect of the Federal Reserve Act in 1913 and the first Secretary of the Federal Reserve Board that became what we now know as the ‘Fed’. He played a role in the monetary structure of other countries, notably advising the Irish government on its post-Independence monetary system. Interestingly, he was the PhD adviser to Charles Kindleberger, known amongst other things for perhaps the best book on financial market bubbles (‘Manias, Panics and Crashes’) and architect of the Marshall Plan.

Willis’ decisive approach in crafting the Federal Reserve Act was to favour the overseeing of monetary policy by experts, rather than more politically oriented actors. He may not have realized it but this legacy is a very important one, increasingly so today.

World affairs is largely divided between experts appointed to judge independently over matters from advances in healthcare, monetary policy and the formulation and prosecution of the law on one hand and elected or politically aligned officials who ‘decide’ on the other. The medical response to COVID, the performance of Europe’s technocrats during Brexit and the alertness of many Western militaries in the context of the invasion of Ukraine are just a few reminders that in a complex world, we need experts.

At the same time, the case for the ‘deciders’ is more mixed, especially with the rise of populism – which by definition pitches experts against political decision makers. What is worrying, especially in the UK is that the ‘deciders’- who typically offset their lack of specialized knowledge with popular legitimacy – are becoming less accountable. There is plenty to write on this, but I will save it for another Sunday.

What worries me are the ‘experts’ and the fact that in many cases they are being left behind by the complexity of our world and are not adjusting their processes to it. Central banking is the prime example.

Notwithstanding the side effects of the invasion of Ukraine, macro assets classes are behaving in an increasingly wild and disorderly manner – take the yen, government bond yields and most commodities as examples. What is grave is that each of these assets impacts livelihoods and businesses in a very real way.

It is now well recognized that the dislocation in markets is caused by the blind, over eager accommodative monetary policy of the COVID period, which itself was conditioned by the over application of QE in the 2010’s. QE became an elixir, suppressing interest rates, boosting markets and wealth.

It also caused inflation, first in asset prices, then commodities and now, aided by supply chain blockages, across the board. In the view of many, and I agree, the Fed and the ECB are chasing a massive policy error, and doing so in an increasingly violent way (threats of 75 bps rate hike at the May Fed meeting).

The risk of policy carnage is high, and the fallout of this could well be severe. In the aftermath, the ‘deciders’ will likely pin all the blame on the ‘experts’ and ask what might be done differently.

I have a few suggestions, 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. Few have ventured forth to declare to the public that whilst inflation across much of Europe is pushing 7%, the ECB’s models say it should be 2%.

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%). There is also much that central bankers can learn from dynamic decision making (the Ukrainian military is a good example) and from new ways of organizing expertise (decentralized organisations).

A further innovation, at least for the Fed and 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 or 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.

Have a great week ahead,

Mike

A couple of weeks ago I mentioned the French adventurer and writer Sylvain Tesson’s book ‘Berezina’ in the context of Ukraine. This week I have recourse to one of his telling quotes that ‘La France est un paradis peuplé de gens qui se croient en enfer’ which, given my perch overlooking the Seine, I fully subscribe to. I often think that if the residents of Bordeaux were transplanted to Birmingham or Seville, they might lament the public goods they had left behind.

The problem is that the residents of Bordeaux and other French cities are attached to their home country and deaf to the argument that the grass is not greener elsewhere. More worrying, well over half of the French electorate has voted for ‘anti-establishment’ candidates in the recent Presidential election, and warnings grow louder that Marine Le Pen might be elected President.

My personal view, based on what I see around me and the sense that while French people express themselves vividly, they are not willing to vandalise their country’s economy and geopolitical standing (unlike Brexit), is that Emanuel Macron will enjoy a second term. Still, it is hard not to feel uneasy about this prediction in a world where logically inconceivable events occur with growing frequency.  

Sitting betwixt France and the outside world, one common misperception I find is the view from outside that France is a chaotic, badly run state. In my view it is the opposite – a complex, centralised, Cartesian machine run by generally competent people. To this end, the person at the very top of this machine must be steeped in its workings, which is why it seems to me very difficult that an ‘outsider’ could become President. For example, the prime minister Jean Castex is not a politician in the traditional sense, but rather a technocrat who knows the machine inside out.

In addition, anyone wanting to undertake a political revolution and take on this machine, can only do so from inside, as Macron has demonstrated.

A side effect of this centralised ‘machine’ is that it produces an elite class, and a broader elite that clusters around Paris. In my experience, France is a more elitist country than say the UK or certainly than the US. Very few foreigners run French companies, and the same is true for  women, and in general for those who have not attended grandes écoles. Unlike say the US or UK, the ‘elite’ labour market is still tilted towards being part of a cabinet.

Now the idea of this impenetrable elite has become part of the political debate. This is reinforced by the fact that with the French state now so large (government spending is 56% of GDP) and debt high, that there is little fiscal space, so much of the political argument pivots to the question of identity.

To this extent, like many other countries, the French political spectrum is shifting from a traditional Left/Right axis to what we might call ‘Upstairs/Downstairs’ where people with different backgrounds and occupations feel that they increasingly have different levels of relevance in society. This configuration is broad but may well make sense to the way a Tunisian software programmer or a Lille based manual worker views French politics.

The important question now is what Emmanuel Macron and the French state will do about this growing divide in the next five years. The likelihood of a disparate, divided parliament and the competing interests of voters on the left and right will make domestic policy very difficult, and Macron might well concentrate his efforts on foreign policy.

The challenge, in my Irish eyes, will be to make French politics more democratic (the EIU rates France as a ‘flawed democracy’ along with the USA for instance) and manifestly more grass roots oriented. Some measures, such as opening up ownership of the press are unlikely to happen, but social media may eventually circumvent this.  

There will likely be a debate on constitutional change after the election, and in terms of France’s political structure it might do several things – hold parliamentary elections before the Presidential one, give much more political and fiscal power to the 13 regions in France, and implement a Citizens Assembly in the sense that Ireland has (i.e. that can help to frame laws and referenda).

In the past, efforts to capture the views of the ‘downstairs’ have been far too haughty and theoretical (I am thinking of Giscard). This is part of the problem – the elite are by design haughty and cultured. A channel needs to be found to give French people a purchase over the politics of their country that translates into clear, practical improvements in their everyday lives. If that doesn’t happen, then an outsider from the ‘downstairs’, with far more talent than Marine Le Pen will step forward and take the Elysée.

Have a great week ahead.

Mike

In early September 1939, the financial press (i.e. Economist magazine) wrote of the robustness of financial market indices, notwithstanding the outbreak of war, and the carnage that would come.

Usually, in less dramatic circumstances, markets have a tendency to fall in the buildup to geopolitical conflict, and then rally thereafter. To date, this pattern has held, though like the aftermath of the outbreak of the COVID pandemic, there is a moral dissonance between human suffering and rising equity prices.

Two years ago, the COVID related rally in prices (markets doubled from their COVID lows) the rationale was that aggressive fiscal and monetary policy, in the context of an accelerated digitization of economies, would boost valuations.

Now, the hangover from that stimulus – a multi-decade high spike in inflation is undercutting bond markets, and arguably should also prove more demanding for equities. Whilst new technology driven trends remain in place, the other change in the narrative is that the invasion of Ukraine has signalled the end of globalization.

This view is ‘late’, globalization has been faltering since the mid 2010’s and has been undercut by events like the snuffing out of democracy in Hong Kong and the failure of the large nations of the world to collaborate during the COVID pandemic. Many of the boons of globalization – low inflation, peace and the spread of prosperity – are now being reversed.

In markets, there are several lessons.

The first, with respect to emerging markets in general and Russia in particular is that the idea of resilience or institutional quality is important. Russian assets have long traded at a valuation discount to other emerging markets because investors were distrustful of governance there. In future, I expect that both bond and equity investors across emerging markets will pay greater attention to the role of factors like institutional quality, democracy and the rule of law when making investment decisions with respect to emerging markets.

In other asset classes, the spike in inflation and the corresponding sell-off in ‘safe’ fixed income is producing a portfolio crisis, the amplitude of which has yet to be fully appreciated. For the past twenty or more years (during globalization) the wealth and asset/investment industries have invested trillions of dollars of client money based on corresponding chunks of equities and government bonds (notionally a ‘60/40’ portfolio).

The ‘death of inflation’ in the context of high growth during globalization meant that both asset classes performed, and then the advent of an overly long period of quantitative easing supported both asset classes, such that for the past ten years the average return on equities was close to 11%, well above the average of 5.5% over the last 100 years.

This era of ‘easy’ returns is likely now coming to an end, and with it the credibility of the investment industry. Whilst it is well known that few investment managers can consistently earn above average returns and fewer still take the kinds of risk needed to do so, many rely on them to protect wealth. The sell-off in ‘safe assets’ like government bonds undercuts this and begs a number of questions, notably because the performance of bond and equity prices has become positively correlated. 

First, there will be more downward pressure on fees for investment funds (especially hedge funds, down 7% on average in the first quarter) and likely more consolidation across the sector.

Secondly and more importantly, there will be a debate as to what constitutes a ‘safe asset’ in the context of rising inflation – the issue being that most portfolio frameworks only permit tiny holdings of assets like commodities and inflation protected bonds.

Some investors believe that the answer lies in private assets, but here again there are several issues.     In the developed world and much of Asia, real estate prices are extremely high (relative to income and GDP) and will likely not withstand rising interest rates. In the US, with long-term mortgage rates rising to 5%, housing related stocks (and increasingly banks). My sense is that much of the rest of this year will be dominated by concerns that the housing market has peaked and will ‘roll over’.

Second, and relatedly private capital assets, notably private equity where there is a large amount of leverage deployed, may also struggle in terms of performance. In venture capital, valuations have followed public markets down, and if you believe in technology driven megatrends (in fintech, health tech and supply chain tech), this may well be the most interesting time to build exposure to high growth companies, the snag for many investors is that access to these opportunities is difficult to realize. 

In coming weeks, my sense is that the market narrative will focus mostly on negatives – Europe’s strategic dis-engagement from Russian energy in the context of its brutal war on Ukraine, the risk that high inflation leads to political instability in countries as diverse as Peru and France and the possibility that Asia is entering a recession (lead indicators in South Korea and China are pointing downwards).

While these events are important in terms of determining the direction of travel of the economic cycle, they should not disguise a growing crisis within investment management. Many in the industry speak about the end of globalization but do not map that on to the viability of their businesses, not the products they sell to clients. 

In 2012, the writer and adventurer Sylvain Tesson commemorated the bi-centenary of Napoleon’s retreat from Moscow by driving (in a sidecar with friends and much vodka) westwards from Moscow back towards France, replicating the journey taken by Napoleon’s disintegrating army.

A crucial point in that journey was the Battle of Berezina (Belarus), where the harassing Russian army chased the French towards the ice filled Berezina River. Heroic work from French engineers meant that a good number of Napoleon’s troops successfully crossed the river, only to be faced with cold, starvation, disease and further attack by the Russians.

The calamity of Berezina was a final catastrophe for Napoleon’s Russia campaign, reducing perhaps the greatest army ever assembled from 600,000 to about 110,000 survivors and curbing Napoleon’s ambitions of European dominance. The only comfort for Napoleon was that the Russians had not pressed him harder, fearing that the end of the Emperor would lead to an ‘even more intolerable’ domination by the British.

Reading this account, some might be tempted to say that in the context of the invasion of Ukraine, little has changed in Europe but the fact is that this war is a terrible interruption to multi-decades of peace and successful diplomatic relationship building (think of France and Germany or the Good Friday Agreement). What is also remarkable is the way in which many of Napoleon’s more positive contributions – in education, law, civil service and infrastructure still define how France operates. It is the world’s fourth military power and the sixth largest economy, or fifth, depending on the pound.

In contrast, Putin’s Russia is hollowed out on many of these variables, and regular readers will know that I often lament the way ‘strong man’ countries like Russia and Turkey allow their political economic infrastructures to atrophy to the point of inevitable crisis. The risk for Russia now is a deep economic malaise and capture by Chinese capitalism.

In the shadow of Napoleon, the question that goes begging is beyond this terrible war, what changes will we see to the geopolitical map of Europe. Bearing in mind that this was the invasion few thought would happen, we should answer this question in an imaginative way.

In the near-term elections this weekend in Hungary will attract attention, notably because it looks likely that Viktor Orban will extend his reign. Orban, at one time an advocate of the ‘open society’ has made a dark and mysterious transition during his political life, towards ‘illiberal democracy’ and somehow magnetically drawn towards Russian power and money (the FSB is believed to be well implanted in Budapest).

In many respects what happens next will be a test of the EU rather than Orban. Brexit has opened up the possibility that countries can leave the EU and the new emphasis on ‘European values’ by the EU makes Orban’s Hungary a very difficult member. My sense is that in the aftermath of the invasion of Ukraine there will be more calls to penalize Hungary (for its closeness to Russia) and to find a mechanism to force its full or partial exit from the EU.

Indeed, some of Hungary’s neighbours may also face greater scrutiny – Serbia may find its path to EU membership slows to a halt, and Austria, a seemingly respectable EU member will be pushed to clean up its intelligence services, banking, legal and property markets to rid them of all Russian influence.  

On the more positive side, Poland is now a political force in Europe, and has an opportunity to make peace with the EU following estrangement over ‘European values’. Together with the geopolitical ‘tigers’ in the Baltic states, I expect Poland to try to steer a more hawkish European approach to security in general and Russia in particular. One ally in this regard will be the USA.

At some stage people will begin to question the viability of Russia’s presence in other countries, from the role of Russian mercenaries in African countries (which we discussed in ‘The Man on the Horse’), the many ‘Stans’ notably Kazakhstan, and in Belarus.

I am simply not familiar enough with the situation in Belarus to understand why there has not been an attempt to topple Alexandr Lukashenko (there has been some civil disobedience, sabotage of Russian trains by railway workers and reports of near mutiny in the army). A change of regime in Belarus would be a very speedy way of destabilizing Russia, if someone wants to have a crack at it.

This is one potential catalyst that could accelerate a geopolitical crisis and reacting of the political map of to the east of Europe. I have not even yet mentioned many of the bigger trends – the remaking of energy policy in Europe and a coming revolution in defence and security policy.

In a week where the head of French military intelligence was fired, for making the same mistake as Napoleon’s army in misreading the Russians, the world we are entering into will produce some very sharp and surprising changes in alignment and political identity across Europe and beyond.

Have a great week ahead,

Mike

Vladimir Putin once observed that one could gauge the mood of American diplomacy by looking at the kind of brooch worn by the late Secretary of State Madeleine Albright. For instance, to parse her elegant book ‘My Pins’, she first wore a ‘serpent’ brooch as a message to Saddam Hussein after an Iraqi government newspaper referred to her as an ‘unparalleled serpent’.

When meeting Putin, Albright varied the message from her pins – ‘hear no evil see no evil’ monkeys to warn Putin over human rights abuses in Chechnya and then a spaceship brooch to mark the collaboration between the US and Russia in space. Interestingly, in the book (p. 110) she notes that Putin ‘was capable…but his instincts were more autocratic than democratic ..and single minded in his pursuit of power’.

Albright was Secretary of State at a time (1997-2001) when American power and by association, globalization, were very much in the ascendancy and Putin was the new kid on the diplomatic block. Before becoming Secretary of State, she was US Ambassador to the UN at a time when the UN had power. It was also a time when Alan Greenspan’s Fed was easily the predominant central bank (the Bundesbank was not far behind), and generally well respected or even feared by investors.

Greenspan’s utterances, usually mystic in comparison to the typically forthright statements of Albright, were carefully followed and scrutinized by investors. He cultivated ambiguity (‘if I have made myself too clear, you have clearly misunderstood me’).

Today, the Fed remains predominant, but in a somewhat different way – in terms of its size and market influence (the role its balance sheet plays in financial markets) it is overbearing, but in terms of the credibility of its leadership team it is increasingly impaired. A share trading scandal, and the appalling policy miss on inflation have degraded its reputation.

Today’s Fed Chair, Jerome Powell, has little suasion over markets (he has the worst track record in terms of equity market reaction to his press conferences). That is a pity, at least for the US, because today in the context of the invasion of Ukraine, central banking now is a critical part of the geopolitical landscape.

At a time when many people (notably this week Larry Fink and Howard Marks) are waking up to the ‘end of globalization’, central banks are raising interest rates and curbing quantitative easing, something they arguably should have done last year, but that now amplify geopolitical risks.

In this way, the end of globalization, the rise of geopolitical risk and the end of QE are all linked.

Quantitative easing tranquilized the (market) effects of many of the world’s troubles and arguably insulated decision makers from the long-run political effects of Donald Trump’s trade war on China for example.  QE helped to disguise the signs that globalization was stuttering from the mid 2010’s onwards.

It has also helped to skew moral and logical views of the world – the stock market doubled in value in the aftermath of the COVID pandemic which has resulted in over six million deaths.

Perhaps the greatest danger has been the dulling of the minds of central bankers, and to a certain degree the politicization of their work (in Europe, the US and Japan). Central banking is a notoriously closed environment where groupthink can dominate – this is reinforced through the job market for young economists, the pressures of markets and the institutional rigidities of many of the central banks.

Here the ‘sin’ of the central bankers has been to deploy an emergency policy tool on a permanent basis. QE1 gave way to successive QE programs and the highly supportive monetary policy enacted during the coronavirus period has been kept in place for too long.

The result of this is blisteringly high levels of inflation, made worse by the economic side-effects of the invasion of Ukraine (wars are typically inflationary). In particular, bond market volatility in the US and Europe is nearing historically very high levels, from which it usually spreads by contagion to other markets (equity volatility is comparably very low).

The geopolitical effect of this is to make Western economies more vulnerable at a time when they need to be robust. It is also to sow seeds of doubt in the predominance of the dollar (which I would nonetheless discount) and in general make markets more sensitive to geopolitical risk.

The overall effect is to create the disruptive financial conditions (higher trend rate of volatility, higher trend interest rates and potentially higher inflation for the near term) to accompany a disrupted geopolitical world. As we have noted in recent missives, these can feed off each other – negative wealth effects, high food prices and the trapping of new home buyers at high valuations are just some of the issues to contend with.

Central banks have badly misjudged the economy and mis-calibrated their policies, and the world is a more unstable place as a result.

Have a great week ahead

Mike

A neat explanation for why Vladimir Putin has found the suppression of Ukraine harder than he thought came to me from a very clever friend, who described how in recent years Putin has committed a series of outrages (assassinations in Berlin and London), provocations (Russian troops bringing ‘peace’ to Kazakhstan) and incursions (Syria, refugee influx’ through Norway and Eastern Europe, Russian money into Western politics) as a means of testing the West’s reaction function.

In most cases, the West had not reacted strongly to these incursions and the theory is that Putin read this and other events such as the disorganised retreat from Afghanistan, as signalling that there might be little international opposition to an invasion of Ukraine. He was wrong (many Westerners also could not have imagined the European response).

That he miscalculated shows that different ‘tribes’ or cultures can look at the same set of events and draw very different conclusions, something that has often struck me when hearing the Russian view of international affairs.

The question I now ask, is whether Beijing, given its cold, and apparently tone-deaf pronouncements on the invasion, have a view of international relations that is at odds with the Western view, and in detail, what lessons China is drawing from Ukraine.

I should preface my remarks by saying that really too few people in the ‘West’ have made enough of an effort to understand Chinese political culture and the forces that drive policy making. That is not made any easier by the veil of secrecy thrown up by the Chinese Communist Party, and the relative attractions for Westerners to live and study in China (I estimate that there are twenty times the number of Chinese students studying in Britain, as there are British students studying in China).

To that end, cultural differences mean that Chinese policymakers may simply not ‘get’ things we see, but that they may well be more keenly attuned to other aspects, such as the response of the emerging world to the invasion. It is also worth emphasising that people around Xi Jinping may draw different conclusions to him, such as the way in which Vladimir Putin is demonstrating the shortcomings of autocracy.

As a final caveat, most people will watch China in the light of its repeated threats regarding the place of Taiwan as a sovereign country (that echo the views of Putin regarding Ukraine) and the repeated sorties of Chinese fighter jets and bombers into Taiwanese airspace.

Broadly, China may notice several things.

First the rapid cohesion of European foreign policy, the increasing singularity with which (coupled with the re-election of Emmanuel Macron) European foreign policy has reformed, and the emerging power of eastern European countries like Poland, not to mention the ‘foreign policy tigers’ in the Baltic states. The immediate, concrete implication for all of this is that the extension of China’s ‘belt and road’ initiative into Europe and its ’16&1’ partnership with eastern European countries is all but dead. Chinese investment into Europe will also face even greater scrutiny.

The Chinese reading of America is more complicated. American intelligence and diplomacy have in my view performed well – and much of the latter has been sufficiently discrete. America has notably paid more attention to the Chinese reaction than Europe has (France will be glad it is not part of AUKUS now). Whether China realises it or not, its international stance on the invasion can see it move from a ‘strategic competitor’ to the US to an outright adversary. A profound breakdown in relations with the US would damage the international economy and international institutions severely, so there is much at stake.

One swing factor for China is the attitude of many emerging countries to the invasion. Several Asian countries – Bangladesh, Vietnam, Laos and Sri Lanka abstained from voting in the UN resolution on the invasion, while notably half of Africa did too (including South Africa) and India’s closeness to Russia is laid bare. To note, many of these countries – across Africa and Asia – have been targeted by Russian info ops.

The fact that the emerging world appears split on the question of Ukraine shows several things – the lure of the Chinese economy and the notion of a ‘managed democracy’ in many countries, and correspondingly the perception that the ideas of democracy and the liberal order may only be something for the West. Pessimistically, it suggests that the post-globalized world order will be a contest between the models of democracy and non or managed democracy.

If this is true, China is in a more comfortable geopolitical situation than it thinks. Equally, parts of Asia are now taking sides – Singapore’s move to condemn the invasion of Ukraine was brave.

Geopolitics apart, there is also much China can observe on how this war is waged. In recent years the Chinese military and navy has undertaken several large-scale exercises with Russia, and the Chinese military is organised in a similar way to the Russians. Given that the Chinese have effectively no battle experience, they must surely wonder if they have the right training partner granted the poor performance of the Russian army (for instance multiple war games by the US Marine Corps University suggested that the Russians would have wrapped up the invasion within three days). Financially, China might well regard Russian assets as opportunistic and cheap.

China will also worry about the ability of the West, the US in particular to detail Russia’s moves before they happened and should be concerned that the US and Japan’s Public Security Intelligence Agency, in addition to other intelligence configurations (Five Eyes) have the ability to read its moves.

The area where China has the greatest scope to learn is in information wars, where President Zelensky and Ukraine have excelled. Globalisation has spread social media, which still retains its Western cultural bias internationally. I can think of very few Chinese media or social media outlets that have penetrated beyond China in terms of creating engaging, trusted content. In short, this means that in an increasingly contested world, China will struggle to ‘tell its story’.

In that respect, I suspect that China feels much less sure of its position on Ukraine/Russia, and will most likely continue to watch and wait, hopefully suing for peace.

Have a great week ahead,

Mike

The Salon de l’Agriculture that takes place at the end of February in Paris is one of the few places (in Paris at least) where you can witness French people tipsy at ten in the morning (they are normally more circumspect than their English and German speaking neighbours), and in general where the atmosphere is far more genial than the practiced nervy, combativeness of Parisien(ne)s. As with many events, this gargantuan festival (which I thoroughly recommend) resumed after an enforced break during COVID.

The Salon is remarkable not only for the displays of agricultural prowess, and the array of foods, wines and increasingly, beers on offer, but also as a political barometer. Since he was the mayor of Paris, Jacques Chirac embraced the event, and is still spoken of as someone who was truly attached to the ‘terroir’. Other politicians fared less well, notably Nicholas Sarkozy whose reply to an attendee at the Salon (‘casse toi pauvre con’) became infamous.

Contemporary French politicians still regard the Salon as an important stage, and a litmus test of their ‘closeness’ to the French people. My sense is that the younger generation of politicians fail this test, Emmanuel Macron has often looked awkward in a combination of suit and wellies, though at this stage I suspect French people accept him for the ‘intello’ that he is. In other countries, at similar events such as Ireland’s National Ploughing Championships, politicians such as deputy Irish Prime Minister Leo Varadkar have also looked ill at ease.

The point of raising the topic of food and agriculture is that it will become an increasingly important political issue, especially so in the context of the invasion of Ukraine. It is this event, rather than his performances at the Salon de l’Agriculture that has propelled Emmanuel Macron into a commanding lead in the forthcoming Presidential elections.

A critical part of the expectations set around the idea of the French president is that he or she can act commandingly on the world stage, and here Macron has delivered. The open question now is how he frames the mandate that the electorate will give him for his second term. He will be keen to take a second run at domestic reforms (pensions for example) and to also play an active part in the making of the ‘new Europe’ (he may well become President of the EU in the future). Once he is re-elected, one of the issues he will face is food price inflation and food security.

In recent notes (Ne vous melez pas du pain II) we have flagged how governments are trying hard to dampen the consumer impact of high commodity prices, as this has historically been fuel for popular unrest. To some extent policymakers can lay the blame for this on Russia and its president, but in many emerging countries where spending on staples makes up nearly 40% of disposable income (i.e. India, and large parts of Africa) this must be worrying from a humanitarian point of view at least.

Many industries are now feeling price pressure. In that respect, my own sense is that the spike in commodity prices is more likely to cause a recession (or demand shock) than an inflationary spiral (at consumer price inflation of 8% some might say we are there already), and there is a risk that markets and central banks overreact to this, having underreacted in 2021. One new trend we may see is popular fiscal activism, where the producers and potential beneficiaries of commodity prices spikes are hit with supplementary taxes.

In the longer term, the spike in food prices may do for food security and the food industry what the COVID epidemic did for digital commerce. COVID meant that we became used to shopping, working and being entertained from our homes. High food price inflation and the Ukraine are a reminder that food supply chains can not only be disrupted but can also become weaponized.

To that end, I can see a great many countries, especially those who do not have the agricultural arsenal of France and Ireland, examining their vulnerability to food security and acting accordingly to become more ‘autonomous’. Sadly, many of the poorer countries of the world that are exposed to weak food security (notably Nigeria, Egypt, Congo, Chad, Central African Republic, Afghanistan, and Somalia) do not have the wherewithal to become more ‘food’ autonomous.

Across developed countries, we can only speculate what this will provoke in terms of investment trends.  One will be a shift towards urban farming (underground farming for example), another is a drive towards ‘artificial’ and replacement foodstuffs (coconut sugar, oat milk) and most importantly of all a deeper emphasis on nutrition. 

We will also rightly hear more about food inequality – and how the food that different social groups consumer is a function of their education, conditioning and social status. An American dentist Mary Otto wrote an interesting book called ‘Teeth’ which shows the startling differences in dental health across social classes and reports that they spring from differences in education, diet, and upbringing.

The strategically important move will come from China, a large country with a relatively small amount of farmable land. China has, in general poor diplomatic relations with its neighbours and in certain cases food security might push them towards a more benevolent attitude to Indonesia and Vietnam and may see China launch a foods focused investment wave into South America.

Have a great week ahead,

Mike  

One of the early, memorable experiences I had of how international economic policy is made came in the late 1990’s when Stanley Fischer, then the second in command at the IMF, came to the Economics Dept. (Princeton) to give a seminar on the manner with which the IMF disbursed money to Russia in the aftermath of the 1998 emerging markets crisis. I, doubtless like colleagues, was surprised that much of the funding to Russia was granted without collateral or what later (i.e. euro crisis) became known as conditionality.

Being the most junior and easily least clever person in that room, I dared not pitch a question to Stanley Fischer, but I still wonder how Russia may have developed differently had the IMF financing been structured differently (at the time it was widely suspected that some of the money found its way to oligarchs and politically active former KGB agents!).

Over twenty years on, some things have not changed. The IMF is still a discredited institution (Joe Stiglitz’ attack on the IMF ‘Globalization and its Discontents’ was published in 2002), and the Russian economy is still fragile, under-developed and riven by corruption. Russia still has the same president it had in 1999, and still has many, many nuclear weapons.

What is new is that from next week, the financial penalties and sanctions enacted on Russia and key Russians will begin to take effect, shrinking the Russian economy by close to 40%, financially freezing Russia and potentially setting in motion socio-political unrest and sadly, an escalation in Russia’s military tactics. As an experiment in financial combat this is unprecedented and will effectively ‘anti-globalise’ Russia (cut off the flow of people, goods, finance).

Here, the lesson of the conflict so far is that whilst many of us expected Russia to focus on unconventional/hybrid warfare, they have concentrated on ‘old fashioned combat’ where as the West has excelled in information warfare (in calling out the detail of Russian moves before they happened) and now in prosecuting a campaign to cut Russia off economically.

In that respect Russia may be glad that it is not a highly globalized country (that might be the fault of the IMF in 199!) but it is a good example that the currency of a country, in the long run, is a decent barometer of its institutional strength. Around 1870, the dollar and rouble traded close to parity, and from then to the Russian Revolution the Russian stock market outperformed the American market by a factor of two. Today, Russia is uninvestable.

The short-term effects of Russia’s financial freeze will manifest themselves next week. There are several elements to keep a focus on – how Russia will stabilize its currency (it may peg it to gold, or to a group of Asian currencies), the decimation of pensions, the political effects of a likely bank run, the operational effect on the economy of so many businesses either closing or being deprived of large chunks of their revenue base, not to mention the cost of the invasion of Ukraine.

Add to that a global financial system that is increasingly strained (funding stress is mounting), and undercut by high energy prices, my sense is that next week the focus may be more on markets than military. The key for that stress to lift a little, will be public proclamation by a number of Fed and ECB officials that the war risks a recession, and that therefore market liquidity needs to remain ample.

The longer-term effects will be more interesting. The response of the corporate world to the Russian invasion has in general been commendable in the sense that so many companies have cut ties with Russia.

In the near future, it is very difficult to see many governments and corporates trusting Russia again and this will entail a permanent hit to its economy, of something in the region of 20%. China and select other countries may try to make some of this up eventually and Chinese investors may try to buy cheap Russian assets, but strategically this will not sit well with the Kremlin.

There is also a growing debate that the West’s cutting of ties to Russia will usher in a race for the ‘next reserve currency’. I recall being in Moscow some years ago and overhearing a story where someone asked Vladimir Putin if ‘Russia is leaving the dollar’ and he allegedly answered ‘no, the dollar is leaving us’. He was right, but is on the wrong side of the trade.

In that context, the assumption is that the Chinese renminbi, currently 2-3% of international transactions, will pick up ‘fx market’ share. I am not so sure – the lesson for China from the Ukraine invasion is that it may want to be less financially connected to the developed world, a strategy that might heavily restrict the international usage of the renminbi.

The other assumption is that crypto currencies enjoy greater usage, and to an extent there has been a pick-up in trading in crypto currencies (though not much of it in Russia). A number of crypto exchanges, underlining their independence from the centralized financial world, have refused to cut ties to Russians. In my view, this will invite regulators to police crypto exchanges and investors will discount the value of companies such as Coinbase.

To stand back a little, the invasion of Ukraine remains brutally underway this weekend. It has (correctly in my view) led to an economic war, from which it is very hard to see Russia escaping financial catastrophe. And, this time, they won’t even have the IMF on hand to help.

Have a great week ahead,

Mike  

A number of the leading scientists and philosophers of the 20^th century – from Karl Popper to Per Bak for example, have spent time thinking about how systems evolve and break down. Their insights are useful today, as globalization disintegrates, and we wait to see ‘what’s next?’.

In the systems literature, frameworks that have become outdated or failed to evolve are undercut by often events. Per Bak framed this as a heap of sand, collapsing when a marginal grain is added. It is not the marginal grain of sand that leads to the collapse, but rather the growing instability of the ‘system’ over time (the fall of communism is an example).

The crisis around Ukraine is yet another grave case, and it helps to clarify several things – the erecting of another barrier to trade from west to east, the arrival of new geopolitical constellations and a deeper cleavage between the democratic and non-democratic worlds. The day after the invasion of Ukraine, the German foreign minister stated ‘we have woken up to a new world’, but the fact is that ‘new world’ has been in the making for some time.

We have seen other tests in recent years – the subsuming of Hong Kong’s democracy, and the many lessons that need to be learnt from the coronavirus crisis, notably the triumph of humanity and medicine and the failure of governments to collaborate. Taken together they point to the end of globalization, or rather the ‘way we lived’ for the past thirty years.

While there is a growing debate on this important topic, the risk is that politicians, commentators and policy makers remain cosily attached to the idea that globalization can continue and will suffer jolts to their consciousness of the sort that Vladimir Putin is administering. There needs to be a sharp focus on the ‘what’s next?’.

The chief element of the post-globalization world will be the emergence of a multipolar world, where instead of a singular (Anglo-Saxon) way of doing things, rival value driven approaches will emerge in Europe and China, to complement the American approach to political economy. The idea of a multipolar world is incidentally something Vladimir ascribes to, though beyond a powerful army his country has few of the ingredients – a strong economy, financial system or soft power – required to sustain a geopolitical pole.

The picture that emerges is of a more frictioned (i.e. higher inflation or less lowflation), fractured world, and regular readers will know that I have laboured this point!

What is new is that companies, financial institutions, international institutions and individual countries are being forced to choose sides as political-economic tectonic plates pull apart. The striking example is the Nordstream pipeline. The SWIFT payments hub could be another.

The deeper the crisis in Ukraine, the more (or less) wedded governments will be to alliances and values, and eventually the clearer the geopolitical map of the 21^st century becomes.

For example, Japan has sanctioned Russia but China stands by it. India, a long-time ally of Russia, is an odd example of a democracy siding with a ‘strongman’, something that will cause tension in its relations with the US and UK. Poland is another example – this crisis and the security imperative it brings may present a chance to mend the differences it has with the EU over ‘values’. Turkey could play an important strategic role, and might ‘come back onside’.

Switzerland, which has potentially terrific financial power over wealthy Russians and Russian commodity dealers, has done little, and the quid pro quo for this may be a much tougher attitude by EU and US regulators to its banks. Internationally, fintech companies and payment firms will have to be more careful where, and with whom they do business.

In general, many large companies have tiptoed around widening diplomatic divides, will increasingly have to choose sides, not only with respect to Russia, but China too. This will be especially the case for those in strategic industries – semiconductors is the prime example, and for large multinationals with business ties to China (e.g. Apple). The flip side of geopolitical risk for large corporations is that in some cases, they feel it necessary to deepen relationships with governments, in strategic areas like AI and data.

On this point, the team at the excellent Longview Economics point out that the asset values of two of the actors that have undermined American democracy (Facebook/Meta and the Russian state – rouble etc) have collapsed in recent months.

In that respect it must be hoped that within political systems, there is a hardening of views around the sanctity of democracy, and that politicians on the payroll of foreign governments in the UK, US, France and many other countries (Africa as well as we noted last week) face sanction. It is also to be hoped that the funding of political parties by outside actors is scrutinised and penalised in a tougher way. In Russia itself, and perhaps more so Belarus, any signs of mass opposition to the invasion will be welcome.

As a final point, to all those European policy makers mugged by reality, is to think about what the new world should look like, and provocatively to think how they can turn events, such that in ten year’s time, Russia is applying to join the EU.

Have a great week ahead,

Mike