Strength and Honour

Over the last year a number of you have pointed out the odd typo or two in my Sunday note. For example, one eagle eyed reader in Brazil registered that I had written ‘South China Sean’ rather than ‘South China Sea’, which is a Freudian slip of sorts.

The real reason the quality of the note may have slipped is that this time last year my ‘editor’ Nicholas Benachi, passed away. In addition to being a good friend, he made sure that the logic and quality of the note were up to scratch. One of his favourite greetings and ‘sign-offs’ was ‘Strength and Honour’, which may have been inspired by his love of bushido and his family’s ties to Greece, not to mention a sweeping appreciation of history.

It is a phrase that comes to mind more and more often in a world where the moral pendulum is swinging wildly, and I often find myself using it as a maxim to scrutinise people, places and projects. Here are a few examples.

With respect to people, especially public figures, ‘strength and honour’ can mean that they are trusted and admired by peers, as opposed to feared or derided. The war in Ukraine has, as wars do, exposed a gulf between those who might fall into the ‘strength and honour’ bracket (prime ministers of Estonia, Finland, president of Ukraine) and those who manifestly don’t (Presidents of Russia and Hungary for instance). What is less satisfying is that in many countries being trusted and admired is not sufficient to get and hold power.

Nation states are easier to gauge in terms of their ‘strength’. In the past I have developed a country strength indicator (David Skilling has developed a similar approach to ‘economic strength’). The idea is to identify the factors a country should focus on in order for it to be strong in the sense of not habitually falling victim to the ebb and flow of the world economy and the pressures of socioeconomic imbalances. Strength in this regard is not necessarily made up of military might or large GDP but rather the capacity to stimulate human development, to withstand economic shocks, and to have a stable society, among other values.  

The idea of country strength is also more than a set of policies; rather, it is a mentality or policy culture that is evident in countries like Singapore and Switzerland that are acutely aware of the potential impact that outside forces (i.e., immigration, currency fluctuations, and world trade) can have on their societies.

One finding that shines through in some of the research projects I have been involved in is that the countries that score well on country strength are also the most globalized. Interestingly, they also score well on many other criteria such as “most innovative nation” or most “prosperous nation.” Most of the countries topping these rankings are small

dynamic economies (Singapore, New Zealand, Sweden, Switzerland, Finland, and Norway, to name a few), plus larger developed ones such as the Netherlands, and sometimes the United States.

What they have in common are drivers like education, the rule of law, and the deployment of education—their intangible infrastructure. In many respects intangible infrastructure is more important for a country’s future than its physical counterpart. These factors can be political, legal, or socioeconomic. Political factors include the degree of political stability or the strength of the institutional framework. Legal factors include the rule of law, tax policies, and intellectual and physical property rights protection. Examples of socioeconomic factors include research-and-development capabilities, business processes, or employee training and education. There are arguably five specific pillars of intangible infrastructure: education, health care, finance, business services, and technology.

In my view, this framework is the key to surviving a turbulent world, where productivity and social stability will be the two most important policy goals. The tantalising aspect for politicians is that building intangible infrastructure takes a long time (they cannot reap short-term gains), and this places a premium on having high calibre institutions and civil service that can prolong the implementation of national development plans. For this reason, some non or partial democracies are good at developing ‘country strength’ (South Korea in the 1980’s and 1990’s).

There is also a good long-term relationship between growth and the quality of a country’s intangible infrastructure, and sharp changes in ‘country strength’ provoke changes in economic performance – Turkey is the obvious example of a country where structural improvements in institutions have been squandered as deep corruption has taken hold and many of the people who had populated its institutions (professors, teachers, judges, army officers) cleared out of its system.

Another country to watch is the UK, which is becoming a serial institutional and economic underperformer on many fronts. The latest data point to note is Transparency International’s Corruption Perceptions Index released last week, where the UK’s rating has dropped sharply, to its lowest level since 2012 (when the study commenced). The denuding of institutions, undermining of civil servants (the inquiry into bullying by Dominic Raab is an example) and a sizeable drop in spending on social infrastructure are part of a worrying trend.

Other countries to watch here are Israel where the country’s legal infrastructure and political system are being undermined by its new government, and then from a more positive point of view – Ukraine’s attempt’s to curb corruption (the debilitating effect that this has had on the Russian army should be a cautionary lesson), and the opportunity that the geopolitical situation the war has created for Poland to reverse the damage done to its institutional infrastructure (notably legal and human rights).

Strength and Honour!


Balance sheet of Jenga

William Miller, a former Fed chairman in the 1970s was known to have joked that 23% of the US population thought the Federal Reserve was an Indian Reservation, 26% thought it was a wildlife preserve, and 51% thought it was a brand of whiskey. On that basis the ECB might be confused with the England Cricket Board and the BoJ as Balance sheet of Jenga.

Miller shouldn’t really have been one to joke – his tenure at the Fed lasted only seventeen months after he flagrantly lost control of inflation, to be ‘promoted’ to the role of Treasury Secretary and replaced at the Fed by Paul Volker – the rest as they say, was history.

We are back at a Volker moment of sorts. Only ‘sorts’ because to Miller’s intuition, it seems to me that the vast majority of people have no idea of the chaos that central banks are sowing in their lives – having pumped excessively cheap money into the economy, trapping new home buyers and then as inflation took off, taking a hawkish turn and raising rates aggressively in an attempt to undo their prior mistake (see our earlier note Pantomime to Farce).

In this context, it strikes me that there is very little public sense of what central banks are doing, and of the accountability of the actions, views and forecasts of the major central banks. Strangely though appropriately, this period of monetary tightening is also accompanied by some introspection as to what the role of central banks is.

For example, in a recent speech at Sweden’s Riksbank, Fed Chairman Jerome Powell stated that the Fed’s mandate did not encompass the role of a climate policymaker. His comments likely reflect a debate in the US, predominantly amongst Republicans as to the extent to which ESG (Environment, Social and Governance) driven policies should be pursued by institutions and investors.

Powell is in my view, correct in the view that the role of central banks needs to be tightly defined, though incorrect if he assumes there is no link between the policies of central banks and climate damage (curiously excess temperature readings and world debt to GDP have risen in tandem since the time QE (quantitative easing) begun). Relatedly few central bankers return to the perspective that a significant opportunity to ‘reset’ finance was missed in the heat of the global financial crisis.

Powell’s attempt to frame the Fed’s role comes at a time when the role of central banks in the political economy is enormous. As they have come to the rescue of various crises – that of low growth in the US, the structural deficiencies of the euro-zone and the economic side-effects of COVID, their role has burgeoned.

Central bank mission creep appears contagious – Janet Yellen positioning the Fed as the ‘cure’ for long-term unemployment, Christine Lagarde as the solution to climate change, and the outgoing Bank of Japan Governor Kuroda positioning the BoJ to swallow the entire Japanese financial system.

What is increasingly absent is a sense that fiscal policymakers are willing to both channel and offset the power of central banks.

First, for crucial policy issues like climate change and wealth inequality, monetary policy is a powerful motivating force but too broad based to have real policy relevance. Here fiscal policy makers need to channel the impact of monetary policy through instruments (such as the issue of green bonds) so that capital is directed to viable green technology projects and similarly to curb its effects on wealth inequality through taxation. Europe is much better than the US in these regards. Where Europe falls down (apart from capital markets and banking union), is in the way individual governments set fiscal policy with respect to the common monetary policy.

The omnipotence of central banks also means that they are an important benchmark for the quality of institutions, and for public policy leadership. For instance, that the ECB’s view on inflation and the outlook for the economy have very little credibility is not a great thing.

Far, far worse, in September 2021 it came to light that very senior Fed officials had been actively trading securities – something that would be unimaginable to most investment bank compliance officers. Interestingly, the moment that the Fed introduced new policies to oversee and effectively stop trading by Fed officials (December 2021 /January 2022) marked the top for equity markets and the onset of a hawkish turn in US monetary policy.

Ideally, this should never have occurred, especially at a time when so many other American institutions – from Congress to the Supreme Court – have been under attack, and it is my sense that most of the previous holders of the Fed Chair would have resigned in such circumstances.

So, if central banks need to do better on the ‘G’ part of ESG they will soon be confronted with the lure of geopolitics. To continue the thread that David Skilling and I opened up at the start of the year in ‘War by Other Means’, and if readers don’t mind, returning to page 267 of The Levelling …

One dimension that may complicate the need for less central bank intervention and diminish their independence is the quest by the large poles for financial dominance over each other. Central banks could become a vital instrument in such pursuits. Echoing Carl von Clausewitz’s view that “war is the continuation of politics by other means,” in a multipolar world central banks could become the monetary battleships of the large regions, with currency wars shadowing trade wars.

Indeed, the epidemic of countries sanctioning each other in 2018 (Saudi Arabia sanctioning Canada, the United States sanctioning Turkey, Russia, and China, for instance) suggests that finance is a key part of the geopolitical arsenal. Against this backdrop, governments may be tempted to allow central banks to take on a more strategic or geostrategic role than the “mere” economic function they play today. For the United States and Europe, this compulsion may well grow. Financial globalization is the only area of globalization where the United States is truly dominant, and using financial architecture to entrench its dominance is a compelling strategy.

In this context, I think that once this rate hiking cycle is over, the major central banks, as well as the minor ones like the PBOC, will spend more time thinking how they can expand the circulation of their currencies (the US in the Middle East,  Latam and with swap lines to Asia, China in Africa, and the euro-zone in Eastern Europe and North Africa) and how they can use their monetary tools against other economies.

Before that, the central banks (note there is an important Fed meeting next week) may have to negotiate a financial crisis – every US rate cycle since 1970 ended with a financial/market crisis. The outcome of such a crisis will have a bearing on the strategic competition facing the world.

Have a great week ahead


Mugged by Reality

History is catching up with me. In my last two notes I wrote variously about the tendency for some authors to use the opening line from Dickens’ Tale of Two Cities…’it was the best of times the worst of times’ and, the ability of ChatGPT to write essays and speeches.

On Monday, I dug out an old speech from Xi Jinping – and to my horror found it contained the sentence ‘it as the best of times the worst of times’, and it was written in such a balanced, anodyne way, with an obvious appeal to the Western reader, that it must have been written by a ChatGPT engine- the Chinese are apparently years ahead of thus here.

The speech in question is worth dwelling on. It was given at Davos in 2017, only a few days before Donald trump was inaugurated. As America struggled with the reality of Trump’s election victory, Xi Jinping came to Davos to claim globalization for China and to place China in the vanguard of the world order.

After the speech I saw American CEO’s wander out of the Assembly, partly in shock and mostly in recognition that China’s time had come. It should have been the beginning of an era for China, but instead it was the beginning of the end for globalization. Xi’s autocracy, China’s hunger for productivity boosting technologies, and Trump’s telling, though infantile, castigation of China, all opened a sharp divide between the two biggest economies in the world.

The Davos crowd is still debating whether globalization has simply changed its spots or stripes, but I think the wider consensus view is that it is being replaced by a multipolar world order (of large regions that ‘do things’ increasingly differently).

What is much less a consensus view is the intensity of the strategic competition between the USA and China, and increasingly Europe. For the moment, Europe’s stance reminds me of the description that Iriving Kristol gave for a neoliberal as a ‘a liberal who got mugged by reality but has not pressed charges’. Europe is being mugged by the reality of strategic competition but has not quite yet decided how to proceed.

Armed with this insight I took my soapbox up the ‘magic mountain’ last week. As ever Davos is a mixture of James Bond and ‘The Pink Panther’ (á la Peter Sellers), with sleek security combining with the rich and famous slipping around on the snow.

On Wednesday we had a very good discussion (thanks to Creative Dock and Roland Berger) around the implications of ‘strategic competition’ for European companies. The audience was mostly made up of German and Swiss business people so I, diplomatically as ever, wasted no time wading into the topic of German politics (I was heavily outnumbered by experts on the topic).

Today, more than any other European country, Germany embodies the dilemma that many nations face of being ‘forced to choose sides’. Having spent decades managing and cultivating relationships with European neighbours and countries like Turkey and Russia, Germany now has to choose.

It must choose between being economically and politically close to the US, and commercially bound to China, more so than it realises. In different ways, it is coming under pressure from the US, and at the same time being subject to a charm offensive from China.

Within German politics, there are also multiple contortions – the Greens acquiescing to coal mining and the sale of weapons is an example, and traditional relationships with the likes of France are fracturing. Perhaps German politicians thought that its economic power would render it influential diplomatically, which was certainly the case – but it has now become a liability.

The debate over the provision of Leopard tanks to Ukraine is sapping Germany’s credibility, and especially that of its leader Olaf Scholz. He appears to be the outlier in a long line of generally impressive German leaders since the 1960’s. If he believes that his indecision will create an environment where negotiations become likely, then he is badly wrong – morally and strategically.

Appropriately, the indecision in Berlin is a reminder of the lack of decisive policy making during the euro-zone crisis. Neither I expect, and again I am not an expert here, does the German public realise the extent to which the political mood has shifted in the West and what other nations now expect of Germany.  

Before I hector Germany too much, I also acknowledge that Ireland may also be on the cusp of a similar geopolitical dilemma. On a per capita basis, it has one of the best and most effective diplomatic services in the world, and a very large stock of soft power. However, it has ignored the creation of a proper defence and security policy and compared to other small nations (Denmark for instance), it effectively has no hard defence capability. It is the opposite of Israel – lots of soft power and little hard power.

The cases of Germany and Ireland demonstrate how crises occur – broad strands of policy are left neglected for years (often for good reasons), and then a shift in the world order makes demands upon them that cannot be met.

We are now living the great geopolitical ‘mugging’.

Have a great week ahead,


Two Cities

Writers or presenters in need of a catchy headline often deploy the line from Charles Dickens’ ‘A Tale of Two Cities’ that ‘it was the best of times, it was the worst of times’. The phrase in question compares London and Paris, around time of the French Revolution.

Having spent Thursday giving a talk on ‘La Guerre par d’autre moyens’ to a group of French economists and then Friday in London attending the estimable Pi Capital’s lunch meeting (Ian Bremmer presented his ‘risks for the year ahead’), I couldn’t help thinking of the ‘Two Cities’ and everything their history has to tell us about the development of economies, power and the state of the world today.

They are the two most extraordinary cities on earth, and no modern city, nor I expect Beijing (for a very long time the most populous city on earth – Rome has the record here) will match their colour.

I have lived in London and Paris for nearly half my life, so a full and worthy attempt to compare and contrast them could take a very long time. O’Sullivan’s Guide to the Pubs of The City and Paris Centre (sponsored by Eurostar) will have to wait.

What is interesting today is how each city confirms the stereotype of the other – London rather than Paris is beset by strikes and labour disputes, alternatively I find Paris more elitist than London and provocatively, I find Parisien(ne)s more polite than Londoners. There are certain elements of British culture I miss – notably the artistry of newspaper headlines. ‘Sex at No. 10 Covid Party’ is one such banner that greeted my arrival in London,

There are a number of serious points in comparing the two cities – not least in the context of the rest of Dickens’ quote that ‘it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair’ which underlined the dangers of the post-Revolution period.

The uncertainty that the French Revolution caused, and that Dickens wrote about, might well map onto Brexit. We are at a point in history where, as the old globalization led order dissipates, the rise and fall of countries will accelerate. For example, Russia, Estonia and Poland have all made strong choices this year, and will reap the consequences – in a positive way geopolitically for Poland Estonia, and quite possibly in a catastrophic way for Russia that could see the disintegration of its geopolitical hinterland and potentially the country become a renegade actor internationally.

Brexit is not quite as bad, but its folly is laid bare every day. Investment, especially in social infrastructure and public goods has collapsed over the past ten years, while productivity is anaemic. In France productivity is healthy, but France is reaching the limits of its budgetary and financial power. So, not entirely unlike the aftermath of the Napoleonic Wars, which drove economic innovation (in England), both the UK and France need to rethink everything they have done in the past forty years.

The UK needs to follow the French model – greater, better spending on education, health (and a less politicised approach to operating healthcare and policing), and possibly also on the military. The UK’s tax base needs to widen and arguably corporate tax needs to rise.

France on the other hand needs to look at what its neighbours are doing well. The heavy burden of administration needs to be cut away – to help businesses and to shorten the gap between the state and ‘the people’. Granted that France is at the limit of its budgetary potential, it has two (non-mutually exclusive) choices – political crisis or innovation. Mass privatisation is a non-starter but the digital economy in France offers the means to use private capital and expertise to improve public services.

As a final, crucial point, the ‘real’ tale of the two cities is how politically they have become estranged during the Johnson years. Brexit and the post Merkel era in Germany have left France the indispensable country in Europe, but with American singularity and Russian savagery on the rise, it needs to be politically closer to the UK (notwithstanding AUKUS) on topics of defense and security.

If this is the case it will suit Rishi Sunak, who I suspect will follow a foreign policy akin to the old Turkish one of ‘no trouble with neighbours’. There are already welcome signs of a change in tack in discussions around the post Brexit trade relationship of Northern Ireland. There is growing urgency to solve this before the 25th anniversary of the Good Friday Agreement in April.

Fittingly then, it has just been announced that Emmanuel Macron and Rishi Sunak will hold the first UK-France summit in five years on March 10, and King Charles III is expected to cross the Channel in late March.

At long last, harmony may reign between the two greatest cities on earth.

Have a great week ahead,




Let me pick up where I left off ahead of Christmas by reiterating the fives themes for 2023 (‘War by Other Means’) that I had put together with David Skilling. The note details the trends we expect to materialise through the year as intense strategic competition between regions takes hold.

What has also become apparent to me over the holiday period – perhaps because I have simply had time to read more and reflect better, is that some of the contours of the post-globalization landscape are taking shape – the geopolitical realignment of the countries of the Middle East for instance, and the forming of currency based geo-strategic relationships, notably in the use of the yuan and rouble to settle commodity trades.

Another profound change that has been taking place is the relationship between humans and technology, in the sense that in many domains now humans are becoming far more effective in their work where they use technology cleverly and with humility. Additionally, still strong labour markets in the context of collapsing technology stock valuations suggest that humans have not been economically eviscerated by technology.

The trade-offs between technology and humans are not a new issue. As with many of the topics we grapple with today – military strategy, democracy and philosophy – the ancient Greeks established the benchmarks that most of us have struggled to keep up with since. With respect to technology, Greek philosophers spoke of automations (robots), engineers like Daedalus were said to have invented moving statues and models of animals, and Greek mythology conjured ‘Talos’ a giant, moving, bronze statue that guarded the island of Crete.

In modern times, the new frontier is where human professionals can use technology to help rather than replace them. For example, within the US military the use of various drones, intelligence centric tools and some weaponised machines by small units of soldiers is an area of keen study and practise, and it is now more than evident that the Ukrainian army has been given a leg up in deploying satellite and AI technologies in prosecuting its defence with increasingly impressive results.

The military use of robots and AI has potentially terrifying outcomes, which is why it is important that both the law and philosophy keep track with the use of technology and set boundaries to its use – to that end some universities are tackling this head on, such as the Centre for Ethics in AI at Oxford. In this respect, an interesting book that I have flagged before, is Aifric Campbell’s ‘The Love Makers’ (see AI – The Final Problem) which provocatively details a world where humans and robots are enmeshed, romantically and in other ways.

In this context, a really interesting recent paper by Cass Sunstein (‘The Use of Algorithms in Society’) highlights the role of AI in multiple domains such as dating, where he quotes the conclusion of a paper by the University of Utah’s Samantha Joel entitled ‘Is Romantic Desire Predictable? Machine Learning Applied to Initial Romantic Attraction’ which holds that the process of romantic attraction may be more “like an earthquake such that the dynamic and chaos-like processes that cause its occurrence require considerable additional scientific inquiry before prediction is realistic.”, a conclusion so clunky it must have been written by a robot.

The Sunstein paper is useful in illustrating how surgeons or judges can use AI and its related datasets in the support of their own roles, rather than competition with them, so that they are wiser, challenged in a data centric way, and hopefully society is better off.

Lurking behind the use of technology and specifically AI by professionals is the fear that it will disintermediate them. A recent development here is the arrival of ChatGPT an interactive ‘intelligent’ bot that has been developed by OpenAI (set up seven years ago to build socially constructive AI, and recently valued at USD 30bn). ChatGPT is catching on quickly, not least because students have found that it can write half decent essays.

I recently tested it out, asking for a response to the question ‘Is globalization over?’- the result is below, and in my humble opinion is a good rendition of the kind of response that a ‘two handed economist’ might give (‘on one hand…on the other’). I think I can just about do better, and if there is any lesson to draw it is for human writers to be more opinionated, quirky or style driven in how they write. I am not out of a job just yet.

Have a great week ahead,

It is difficult to say whether globalization is “over,” as the term can be interpreted in different ways. Some people use the term to refer to the increased interconnectedness of the world’s economies, while others use it to refer to the spread of Western culture around the world.

In terms of economic interconnectedness, it is true that globalization has slowed down in recent years. Trade growth has slowed, and there has been an increase in protectionist policies such as tariffs and trade barriers. However, it is also important to note that globalization has brought many benefits, such as increased economic growth and the spread of technology and ideas.

It is also worth noting that globalization is not a new phenomenon. Throughout history, people and goods have been moving around the world, and different cultures have influenced one another. While the pace of globalization may have slowed in recent years, it is unlikely to come to a complete halt.

In terms of the spread of Western culture, it is also difficult to say whether this process is over. While it is true that other cultures and ways of life have been influenced by Western culture, it is also important to recognize that there is a growing appreciation for cultural diversity and the value of preserving cultural traditions.

In conclusion, it is hard to say whether globalization is “over.” While there have been some changes in the level of economic interconnectedness in recent years, it is unlikely that the world will become completely isolated from one another. Similarly, while Western culture has had an influence on other parts of the world, there is also a growing recognition of the value of cultural diversity.

War by Other Means – Positioning for 2023

War is a mere continuation of policy by other means’, General Carl von Clausewitz

As we end a turbulent 2022, I have been thinking about what firms, investors, and governments should be positioning for in 2023 (and beyond).  This year, together with David Skilling (long-time collaborator and LandFall Strategy Group CEO), we have prepared a paper on key dynamics that will shape the year ahead.

This shorter note sketches out our view on these dynamics.  Please get in touch (through LinkedIn or by email) if you would like to access the full report. 2023 is likely to be another volatile year.  This ongoing turbulence reflects not just idiosyncratic shocks, but also a regime change in the global economic and political system. 

After the end of the beginning

Our core thesis is that the global economy is moving onto a ‘war time’ footing, with increasing, broad-spectrum strategic rivalry between the big powers reshaping the global economic and political system.  The key domains for this strategic competition relate to economics, finance, and technology – extending well beyond military competition. 

Increasingly, government policy across multiple areas will be deeply shaped by this strategic competition, from macro policy to industrial policy and the net zero transition.  In turn, economic outcomes, the business environment, and markets, will also be affected.  2022 was the ‘end of the beginning’ for the new regime, and these realities will powerfully shape 2023.  The global economy has been relatively depoliticised – but politics is firmly back.

Note that we are not forecasting a ‘war’, but Clausewitz’ terminology is useful to describe an increasingly contested world.

Previous episodes of regime change have had big impacts on investment returns, profitability, and national outcomes.  New approaches are needed to prosper in this new context.  

We identify five major themes associated with this regime change and their implications for firms, investors, and policymakers: from a changing globalisation model to the return of the state and changed macro policy settings. 

Globalisation & strategic autonomy

Globalisation is changing in structural ways.  Economic factors are partly responsible, supporting reshoring and nearshoring.  But domestic politics and geopolitics are much more disruptive factors in reshaping global flows.

In domestic politics, there is a growing push for strategic autonomy and independence in key sectors.  Industrial policy has crossed into protectionism.  The Inflation Reduction Act and the CHIPS and Science Act in the US are two examples, with sweeping local content provisions.  The EU and numerous national governments are likely to respond with industrial support packages of their own through 2023.  And China will continue to strengthen its development of national champions. 

Relatedly, growing geopolitical rivalry between the US/West and China will powerfully shape global flows.  The US has imposed restrictions and sanctions on China, notably on semiconductors, and is looking to decouple parts of its economy.  Similarly, Europe and others will continue to reduce economic exposures to China, albeit in a more gradual manner.  China’s policies also push in the same direction – reinforced by observation of Western-led economic sanctions on Russia.

2023 will be a year in which we move into much more explicit political competition and tension in globalisation, with a more fragmented global economy emerging rapidly.  The recent G20 meetings put some guardrails around the US/China relationship, removing some of the tail risks, but the logic of strategic competition remains intact.  Firms and countries will need to make deliberate choices.

The return of the state

After a few decades of declining government spending, interrupted by the global financial crisis, the size and role of the state is expanding.  The pandemic and energy crisis support packages reflect changing expectations on the role of government and will be difficult to reverse, particularly into a slowing economy.

And beyond the pressures for transfer payments and the costs of an aging population, strategic competition will lead to increased government spending.  Many governments have committed to raise military spending to 2% of GDP (or more); significant investments are being made in the net zero transition; and there is increased spending on industrial policy initiatives. 

Beyond financial support, governments will also take a more expansive role in trade and regulatory policy to support key strategic sectors and building national champions. There will be pressure to increase tax revenues to fund this spending.  Wealth and asset taxes will become more prominent, together with windfall taxes and higher corporate taxes.  An increasingly progressive tax system is likely.  Efforts to reduce international tax competition, such as the OECD’s minimum corporate tax rate agreement, are consistent with this.

Given the magnitude of the likely increases in government spending and investment, the quality of those decisions will make a substantial difference.  State capability will become a core driver of national competitive advantage.

Democracy fights back – and the autocratic recession.

The strategic competition between big powers has sometimes been framed as democracy versus autocracy.  This is not an entirely accurate framing, but it does capture something.  As some Western political systems have stumbled over the past several years, they have often been compared to apparently high-performing autocracies like China.

Yet as we look into 2023, democracies are on the comeback after a period of ‘democratic recession’.   The centre is holding and populism is broadly on the retreat.  Across Europe, reasonably centrist parties are in dominant positions.  The US remains deeply divided, but the centre is also stronger. This dynamic is partly because democracies have been responsive to popular preferences through challenging times (Covid, energy crisis); and it may be that the increasingly evident strategic competition has led to greater seriousness.

There are of course challenges to democracies.  One of the biggest challenges in 2023 will be managing the redistributive implications of high inflation: real wage growth is negative, household budgets are squeezed and borrowing costs are increasing.  High inflation is weighing on public support for governments. 

In contrast, an ‘autocratic recession’ is more likely.  China will face major political issues through 2023, most notably getting out of the Covid corner it has painted itself into.  And the Chinese economy is slowing structurally, with increasing youth unemployment.  Iran is struggling with poor economic and social outcomes and political discontent.  And the Russian economy is likely to struggle to a much greater extent in 2023.

China, Russia, and other autocracies were on the offensive over the past decade, sensing democratic weakness.  But democracies now have more reason for confidence in their model. 

Macro unravelling

Strategic competition will also contribute to an unravelling of the macro policy order.  

We expect inflation to drop in 2023 but to remain stubbornly above target – including for structural reasons, such as frictions on globalisation and higher government spending.  As a result, interest rates will also remain at a high plateau.  This will create a range of macro risks, as pressure is placed on leveraged parts of the global economy. 

At the same time, the shift to a war-time economy will challenge the current macro policy regime: fiscal rules with a focus on fiscal sustainability, and independent central banks with a price stability target.  Higher government spending and investment will run into the constraints of fiscal rules and central bank inflation targets. 

If the choice is between strategic priorities and existing macro policy institutions, it is likely the institutions that will give.  There will be a shift from policy rules to policy discretion: a relaxation of fiscal rules and softer inflation targets, perhaps with diminished central bank independence.  QE will be difficult to end.  Higher trend inflation is likely as macro policy remains accommodating. 

By way of analogy, the US decision to unilaterally exit the gold peg in 1971 was due to the tension between its strategic policy objectives (domestic spending, the Vietnam and Cold Wars) and macro policy rules.  Similar pressures will become more evident in 2023.

The USD will remain dominant, but there may be some changes in the global financial system.  As one example, it seems unlikely to us that the HKD peg can be sustained given the rivalry between the US and China.

The commanding heights: the technology & energy revolution

Technology is commonly thought to dominate the commanding heights of the global economy, and national economic policy is often focused on developing an edge in technology.  China, the EU, the US, and others, are increasingly investing in strengthening strategic autonomy in leading technology sectors.  Through 2023, we will see increased government capital flow into strategic areas of technology. 

Economic sanctions and restrictions are being placed on technology flows and investments between the competing blocs – and this will strengthen through 2023, drawing in a broader range of countries.   Choices will need to be made.  There are costs to global economic fragmentation due to the push for strategic autonomy.  But as in other domains, competition between countries can be a good thing – creating sharper incentives for investment and innovation (as during the Cold War).

In addition, energy remains a core element of competitive advantage.  The US is advantaged with its high measure of energy independence relative to Europe – which is currently facing competitive pressures, particularly in energy intensive sectors.

Energy investments, particularly renewables, will be accelerated in 2023 for several reasons: in response to the current high prices and supply concerns; as a matter of industrial policy; to comply with net zero targets; and as a matter of strategic autonomy.  Economies that can rapidly move to renewables (electricity, green hydrogen) will be advantaged. 

Those countries and firms that can combine technology leadership as well as security of supply of critical flows of commodities and energy will out-perform.  As technology and energy are increasingly framed in strategic terms, the pace of change will increase markedly, generating significant investment opportunities. 

For a full copy of the paper – including implications, our views on wild cards for 2023, as well as things not to worry about – please get in touch by reply email or at for the full report.

The Autocratic Recession

I am in the middle of writing a book on French democracy, and not for the first time I wonder if I have the wrong country. Often in recent months I have felt I should have been scribbling about America or the UK, but now unrest is bravely picking up in Iran, and then, surprisingly we have the most political, widespread and angry outbreak of protests across China. It might well be too bold a view to say that the democratic recession is coming to an end or has troughed, but a ‘Spring’ in autocratic countries would be a welcome development, provided it ends well (please note that 15 of the 16 countries in the last ‘16’ round of the World Cup are democracies’).  

China is crucial and fascinating here. Having crowned himself as leader for ‘a very long time’ and triggered a transition from one party to one man, Xi Jinping’s hubris could not have been greater (see an earlier note ‘The Red Curtain’), and this has now been punctured by public calls for his resignation.

Having enjoyed an easy two years whilst the rest of the world suffered greatly, China is now mired in COVID, direly so in the context of the government’s autocratic and heavy-handed crackdown. In some ways it has had little choice. Chinese vaccines are not as effective as Western ones and a very large number of older Chinese people have not had a booster jab.

Neither does China have the public health infrastructure of the West. It has, on a per capita basis, one seventh of the nurses that Germany has, and one tenth of the ‘emergency’ hospital beds of Germany (though, life expectancy in China surpassed that of the US this year, still well behind the EU). It could not cope with a public health emergency – by the standards of how America dealt with COVID, China could suffer 4 million deaths, or 2.3 million using Taiwan as a benchmark. In that respect, a harsh lockdown makes some sense.

What is new, is that the lockdown has given the bulk of China’s population a bitter taste of

autocracy. In some cases, factory workers have been treated in a way that makes Oliver Twist’s trials look like a luxury holiday. Granted that the lockdown cannot end immediately and must endure till the spring in some form or other, there are two very important, long-term questions to answer.

The first is whether the manifestation of Xi Jinping’s autocratic strategy breaks the patience of the Chinese people, and the contract between the people and the state (CCP). Second and relatedly, is whether autocracy is bad for productivity, and if so China hits the productivity wall and regresses. In my view, in the grand scheme of strategic competition between China

and the US, this is far more an important issue that a potential invasion of Taiwan.

Chinese growth is slowing and like many other countries it may be in a recession. More tellingly, its trend rate of growth has come down significantly (3%) and given worsening demographics, stronger productivity is really the only recourse to higher growth. This is why autocracy is a problem.

To parse the academic work in this field, autocracy and rising productivity can go hand in hand in early developmental economies, but as the very different paths of North and South Korea show, the development of strong institutions and potentially a democracy, pays a sizeable economic dividend.

There is a good deal of evidence to show that political instability or sharp, negative changes in institutional quality can damage productivity. Turkey is another good example of a thriving economy shrunk by deepening autocracy and corruption.

At the other end of the spectrum, the consistently most productive and innovative economies are those countries (Nordics, Ireland, Switzerland for instance) with the best institutional and democratic ‘quality’. They exemplify open economies and open societies.

Cracks are now starting to show in the Chinese model. That Jack Ma only feels secure in Tokyo suggest that there are limits to entrepreneurial leadership in China. The property and shadow banking system are under stress and the disconnection of China from the rest of the world (diplomatically, flow of people) are just some of the factors that will curb innovation, risk taking and productivity in China.

Any talk of a ‘rising’ in China is misplaced, and equally the place of Taiwan is not fundamental to China’s progress. However, if it is to become a dominant power its economy must develop structurally, and this is where autocracy may become the biggest obstacle that China faces.

Have a great week ahead,


From Pantomime to Farce

This time last year we wrote an article entitled ‘Pantomime Monetary Policy’ where we mocked the denial and inaction of central bankers in the face of rising inflation, especially high asset price inflation. For much of 2022 central bankers bleated that inflation was ‘transitory’, but with consumer price inflation now tagging 8-10% across the Atlantic, they  are now of the view that ‘there are few signs that inflation pressures are easing’ to quote the latest Federal Reserve meeting minutes. Now they may get it badly wrong again.

As the central banking chorus grows, an array of macroeconomic indicators are dropping sharply like fizzing meteorites to earth – components of the Conference Board lead indicators, Philly Fed Survey and Empire State Manufacturing indicator – have all fallen to levels only seen during the 2008 recession. Financial liquidity is contracting rapidly (this has proven a good indicator of where inflation goes, with a lag). Note that if inflation doesn’t fall, then liquidity must contract even more.  

Economic sleuths will have noticed the recent drop in the price of oil, welcome from an inflation watching point of view, but a move that also tells the story of weaker growth ahead. Together with the drop in some of the above-mentioned releases, this suggests that a recession is not far away, if not upon us (curiously the Fed economic forecasts and those of the White House exclude such a scenario). More compelling evidence comes from the bond market where there is an epidemic of steeping if different calibrations of yield curve.

Yield curve steepening occurs, in very simple terms when longer maturity bond yields (10 year for example) fall well below shorter term ones (2 year), essentially forecasting weaker growth in the future. Unlike equity markets, which have predicted nine of the past five recessions, the yield curve has a better record, predicting six of the past five recessions. Another important indicator is the health of housing markets. In the rate sensitive and generally over valued and over leveraged markets (Canada, Sweden, Australia and New Zealand for instance) aggregate prices are dropping

Many economists are now sounding the alarm, and readers should brace for a media debate on whether we get a W, V or U-shaped recession. As it stands, unlike government bond markets, corporate bond and equity markets are not pricing in a recession and may well be vulnerable.

But, the outlook is however more complex than that.

Notably, different elements of the business cycle are behaving in odd ways. While lead indicators and more speculative indicators of inflation (lumber, used car prices for example) are dropping, labour markets are very strong and in general business activity seems to be healthy. Many of these elements may disimprove with time, or a lag as economists say, but these strands of strength make for several dilemmas for central bankers.

Do they for example bludgeon the cash rich consumer and healthy labour market in order to force inflation down or permit a higher level of inflation to stay in place with many unforeseen consequences for companies and asset prices. As it stands, there is a risk that interest rates run high for too long – thus discovering hitherto hidden pockets of risk and leverage. This will be a key story for 2023 and we will come back to it. An additional strand of this story will be the acute social and wealth inequality related aspects of this.

There are two more things worth saying about the business cycle.

The first is that it has been distorted and vandalized by a range of factors – lengthened and prolonged by both globalization and low interest rates (the three business cycle expansion phases during the period of globalization were the longest on record) and then the effects of COVID on labour markets, consumer preferences and fiscal policy. The commercial rupture between the US and China will also skew it and most likely the large outstanding debt load across many countries and companies will produce shorter, staccato’d business cycles.

Second, and finally there are not enough policy makers with a vision for the structural improvement of their economies. Liz Truss managed to identify a low trend rate of growth as a problem, but her response to it was hopeless. Since the global financial crisis, policy making across different countries, notably Europe, has been about crisis management. As such there are few large economies that are targeting gains in productivity and build infrastructure in new economic areas. When that happens we will be free of unconventional business cycles.

 Until then, we are in the hands of the central bankers.

The Kennedy Tapes

In a June note ‘Summer Surprises’ we spoke of tail risks to the war in Ukraine, noting the risk of a missile strike on Poland. In that respect we were not surprised by Wednesday’s missile hit on Poland, though relieved that it was not graver, and perhaps, more deliberate.

Oddly, the incident in Poland made me think of the evening of June 30, 1998 when Argentina beat England on penalties in the World Cup. I had rushed back from London to watch the match, having been to a more interesting event – the European launch of a book called ‘The Kennedy Tapes’. Memorably the book was launched by Caspar Weinberg, one of the longest serving secretaries of defense (his efforts to become secretary of state were stymied by the likes of Jimmy Baker and George H Bush). His introduction to the book that evening was passionate and telling, even for a Republican.

To give you more detail, ‘The Kennedy Tapes – Inside the White house during the Cuban Missile Crisis’ edited by Ernest May and Philip Zelikow, is a compilation of the conversations that John Kennedy, his brother Bobby and advisers held during the Cuban Missile Crisis – JFK had had recording devices fitted in the Oval Office to record his meetings and deliberations. Apparently, JFK was incensed that some advisers had backed the Bay of Pigs invasion privately but later publicly gave opposing views (there is more detail at the JFK Library).

When I read the book, I recall being struck by how thoughtful and strategic JFK and Bobby were (by the way there is a very good book about his murder ‘Who Killed Bobby?’ by Shane O’Sullivan, not to mention the film ‘RFK Must Die’). The book does not dwell on what produced the Cuban crisis but gives a superb and dramatic insight into the reaction of the Kennedy administration to it. JFK and his brother are generally calmer and more considered than their public reputations allow, and it is largely owing to this ‘calm’, and the advice of capable advisers, that an escalation did not occur.

Historians, politicians and public policy practitioners should read the ‘Kennedy Tapes’, even today, where the dilemma that the Kennedys faced is now ever present. Consider that the US/Japan/South Korea ponder the ever more powerful missile tests of North Korea, the now near public shadow war between Iran and Israel over the former’s nuclear program, the potential threat to China’s southern flank of a Japanese nuclear missile program or even the acquisition by Taiwan of long range missile technologies, the many risks from Russia’s arsenal to Ukraine and Europe, and to depress readers even more, the risks that terror groups acquire high level missile technology and deploy it into Latin America or Europe.

With respect to the immediate risk of a Russian strike into Poland and the threat of an attack on a NATO or western country, leaders will do well to follow the deliberate strategy evident in the Kennedy Tapes.

Whilst I have read a few books on war, I am not a military strategist, though I have enough experience with econometrics to know that tail risks are rising. This can encapsulate the possibility of some form of truce or settlement (perhaps Turkey or India or even China will be the initial matchmaker) but also of more sinister action by Russia given Ukraine’s progress in the south-east of the country. I suspect that the more Ukraine forces the Russian army back and the closer they approach Crimea, the heavier that attacks on Ukrainian infrastructure will grow, and as some hold, the prospect of an aggressive attack on the Ukrainian president will also rise. The recent meeting in Ankara of Bill Burns (CIA Director) with his Russian counterpart is a demonstration of the very serious undertones to the tail risks present.

There is a common thread in the ‘Kennedy Tapes’ and Bill Burns own recent book ‘The Back Channel’, that of the value of diplomacy. Worryingly in the cases of Iran and North Korea, the limits of diplomacy appear to be exhausted – by North Korea’s increasingly belligerent and attention seeking missile tests, and by Iran’s decision to supply weapons to Russia. In 2023 we may well see ‘Cuban crisis’ style deliberations around these two countries, both of which present dilemmas for Western policymakers.

In the case of Iran, any outside aggression or perceived interference could derail what is a surprisingly robust (though bloody) protest movement. In North Korea, the calculation is one of geography (namely the proximity of Seoul to North Korea) and of the viability of Kim Jong Il’s regime. And that’s before we have even considered Taiwan.

Have a great week ahead


Odd Couples

Spats between Europe and the US tend to be tempestuous, short-lived affairs – thankfully. In the Suez Crisis, Britain and France stormed towards Egypt only to be reined in by a raise of the American eyebrow. Dominique de Villepin’s speech against the invasion of Iraq was a glorious affair (please read the bande dessinée ‘Quai D’Orsay’ or watch the film of the same name with Thierry Lhermitte and Julie Gayet), but the tanks still rolled in. Then there was ‘The Donald’, lecturing the Germans on their energy and security policies, to guffaws of laughter and much derision, though he was quite right in the end.

Now, there is another, largely avoidable, though consequential tangle coming between the US and Europe. America’s increasingly concerted efforts to nobble the Chinese economy, and Europe’s slow awakening that it finds itself in strategic competition with China and to an extent the US and must boost its ‘strategic autonomy’, are two geopolitical threads that risk crossing each other in a disorderly way.

The complications of this intersection of interests were on display last week as Olaf Scholz visited China- a man standing nervously on cracking geopolitical ice flottes – he managed to disappoint everybody. His coalition partners were vexed, France’s proposal for a joint EU visit was spurned and America wondered whose side Scholz is on (that of German industry is the answer).

This tender diplomatic environment is just one outcome of a world where globalization as we know it has crumbled and we are now in the interregnum phase before the contours of a new world order are established. The problem being that two or maybe three parties want to establish the rules, standards and institutions of that world order.

There are several problems. America wants to have its diplomatic cake and eat it – it expects Europe and other nations to disengage from China – recall the diplomatic error over the creation of AUKUS. Further its domestic fiscal policy is reinforcing the negative side-effects of its foreign policy. For instance, European car manufacturers will suffer the consequences of the Inflation Reduction Act (David Skilling elaborates on these points in his recent ‘Peak West’ note).

Europe by comparison wants to bake its own cake but doesn’t quite know how. The idea of strategic autonomy has yet to fully take flight – and to be cruel this has yet to evolve beyond ‘strategic yogurt policy’ (in 2005 the French government shielded Danone from a takeover bid by Pepsi).

In a world where the three large regions are fast developing distinct expressions of their values, Europe and America have a common cultural and historical thread and share an interest in promoting democracy. On both sides of the Atlantic, democracy is under threat – from within by populists, and from without by anti-democratic countries like Russia and China.

In that respect, we ask what can be done to ensure that Europe and the US do not trip over each other as they keep an eye on the bigger picture.

The first is that American companies and policy makers need to take into account that the narrative in Brussels and major European capitals has changed towards ‘strategic autonomy’ across a range of fields (defence, telecoms etc) and anyone wanting to do business across Europe needs to fit their pitch into this framing.

The second, related element is that Europe needs to do at least two things – give itself a chance to establish strategic autonomy by putting in place the capital markets, tax frameworks and incentives that will allow innovation to thrive. We are far from this point and there are too few pan-European consumer and fintech platforms – Sumup is one, Doctolib becoming another. The second is to help partners like the US to understand the mapping of ‘strategic autonomy’ and where they can be involved commercially.  

The US and Europe ideally need to work more closely on stemming external interference in their electoral processes in particular, and economies in general. For instance, this time last year Europe announced its democracy package – aimed at safeguarding interference on political funding, media and voting rights – but it is effectively porous given the ability of foreign actors to penetrate individual countries without proper surveillance and sanction.

Then, there is talk that the G7 could become the organising body for the democratic Western world – though in effect this boils down to the US-EU axis. There was a time when the UK acted as a bridge for the US into Europe, but Brexit and the degradation of the UK’s soft and institutional power by Boris Johnson have broken this bridge – it may now be up to smaller states like Ireland to better interpret and marshal an open, diplomatic exchange between the US and Europe.

Such a move might help the US-EU axis but then the bigger question remains as to what the EU and US do together- would they try to destabilise public life in China or adopt permanent sanctions and restrictions on Russia. This might well be a false avenue – the best they can do together is convince the likes of Indonesia, Bangladesh and India to move closer to them and thus tilt the balance away from autocracy.

Have a great week ahead