In 1940 PG Wodehouse was (as he might be) spending the summer in Le Touquet, when he found himself surrounded by German troops and interned. Naively, he agreed to be interviewed by a Nazi propaganda team about his internment, and the subsequent diffusion of this led some in England to denounce Wodehouse as a traitor. He was stoutly backed by the likes of George Orwell (who wrote an essay ‘In defence of PG Wodehouse), but Wodehouse’s denigrators left him disenchanted by England and he spent much of the rest of his life in the US.

There should have been little doubt as to where Wodehouse stood on fascism. His 1938 book ‘The Code of the Woosters’ is famous for his comic undermining of the character Spode, a black shorted fascist, most likely modelled on Oswald Mosley.

There are a few other examples of the deployment of comedy to bring fascists to earth, the best of which is Charlie Chaplin’s ‘Great Dictator’, which I strongly recommend. Then, there is the recent Putin/Lukashenko production of ‘Wagner’, which has (by their own admission) confused the best spies in the West, and drained the credibility of Russia’s dictator.

Unfortunately, that is not the end of fascists, electoral systems around the world are spewing them out. Take a few examples. While the main outcome of last week’s Greek general election in Greece was the majority that New Democracy has garnered, 12% of the seats in parliament are held by far-right parties including the badly disguised neo-nazi Golden Dawn party.

In the forthcoming Spanish election, the far-right Vox party may be crucial to the formation of a government and in German the ugly AfD is on the rise. I distinguish these groups from ‘right wing’ parties by the fact that they shamelessly cultivate links to fascists.

In this context we have to ask what is prompting the significant rise in support for the far-right, how ill it will shape national and international politics, and in the context of Wodehouse, we should not be naïve in the face of this new trend.

In Europe, the first wave of far right political support is generally understood to have come in reaction to the global financial crisis, and a group of German researchers have detailed this. Now it appears to be a reaction to immigration, inflation, identity politics and in some cases a sense of overbearing government. Many of the far right parties in Europe are generally mute on the issue of economic policy and most, while lauding family values, appear to want to make their countries unfriendly to families.

There are few if any far right parties who have entered government and left with their country improved, and in this respect the rise of the right is a concern. In recent years, their track record is Brexit and the ransacking of American democracy.

In the greater scheme of things, the rise of the right is part of the battle against liberal democracy and a marker of this is that in some countries – gay rights and women are coming under attack by the far-right.

In the near term, the political implication of the rise of the far right is that right wing and centrist parties will be tempted to move further towards the right – and this debate is accelerating in France this weekend.

Centre-right parties should however bear in mind that an important lesson from Brexit and indeed the career of Donald Trump is that the rise of the far right is often supported by their co-option by the right (i.e. the Tories enabled Nigel Farage and then became a bastion for the likes of Suella Braverman). In that respect the outcome of the forthcoming Spanish election will be interesting (in so far as the PP are willing to go into power with Vox.

Whilst the far right have typically copied the Spode approach when it comes to political theatre, a new element is that they are increasingly linked across countries. Steve Bannon has worked with Marion Marechal on a ‘school for the far-right’ and Giorgia Meloni and Mike Pompeo are close. Operationally, many far right parties use the same rhetoric, ideas, social media tactics and often have the same backers. At a far murkier level there are ties between the far right in Hungary and Greece and the underworld, and in many countries, these parties have tendrils to Russia. 

In the end, the far-right usually defeats itself, the question is whether the damage they inflict on society and the democratic process is too much, and if so how to curb them. Preventing far right parties entering the democratic process would itself be undemocratic, but they (together with mainstream politicians – I am thinking of Boris) should be subject to stricter campaign finance laws, oversight of their use of social media and full disclosure of their links to foreign states.

In a week where Jair Bolsonaro has been banned from politics for eight years, voters and parties of the centre need to react to the rise of the far right and adapt to it in the knowledge that as a movement it has created rather than solved problems.

Have a great week ahead

Mike 

‘Whatever form a new war may take, whatever part is taken in it by aviation, by gas, by the different destructive processes of modern warfare, there is one imperious necessity, and that is to prevent the violation of our territory by enemy armies. We all know the cost of invasion, with its sad procession of material ruin and moral desolation’.

In an age where we watch on the violation of Ukraine, wait to be annihilated by AI powered robots or sit patiently for the South China Sea war to kick off, the above quote strikes a chord. It comes from a speech in January 1930 by André Maginot, then French Minister for War, who at this stage had been lobbying actively for the barrier that bore his name.

Maginot had fought in the first world war (effectively losing a knee), where heavily fortified structures and defensive lines had slowed the Germans, and the conception of the Maginot line relied largely on history – in the previous thousand years the Germans has predictably charged across the space that the line occupied. In May 1940 Rommel sped through Belgium and the Netherlands, around the Maginot line, and by June German troops were on the outskirts of Paris.

Today, the Maginot line might be the large navies of China and the US, or the web of artificial island bases that China has constructed. What is sure is that we are now in a multi-threat age (of total war) where single use Maginot lines can be rendered useless by multi-domain attacks.

One important and complex element here is that Europe is beginning to build its defences for the consequences of a multi-polar world. Last week it announced the skeleton of its EU Economic Security Strategy, whose aim is to protect key EU technologies, identify and pre-empt economic security threats to cyber, intellectual property, and economic coercion against Europe. The framework is designed to allow states to ‘risk manage’ their diverse exposures to these risks, with a steer from the EU. In effect the initiative builds on a number of more specific Acts – such as the EU Chips Act and 5G Security framework.

In practice the initiative has been motivated by cyber warfare from Russia, the implications of the invasion of Ukraine (and financial flows in and out of Europe to Russia) in addition to the threats to EU intellectual property from foreign states (namely China). We can now expect to see more intensive screening of the export of key technologies from Europe, financial inflows and of inward investment. Watch out next week for the announced risk framework to be debated at an EU leader’s summit on 29/30^th June.

The initial implementation of the framework will be interesting, and my sense is that it will initially be used to bring expertise from ‘strong’ states, through the EU, to shore up weak points – from Chinese data centres (i.e. TikTok) in Ireland to foreign ownership of EU infrastructure to the allocation of research funding, to financial flows through Austria’s trust system.

As readers will know I am inordinately focused on the Irish case, and it is a country with multiple ‘Maginot weak points’. The changing world order has uncovered multiple vulnerabilities in Ireland’s security framework – the susceptibility of large technology facilities to espionage, unguarded trans-Atlantic cable lines and a wide-open airspace to name a few. There is now a public consultation process on security ongoing in Ireland, and a suspicion that its defensive frailties are already being filled by NATO countries.

In the EU, one practical implication of the new economic security framework will be the extent to which practices by ‘strong’ states (for example the Netherlands has been very aggressive on protecting the semiconductors industry and on screening Chinese students) will be carried across to other countries, and to the extent that the ‘weakest link’ states have their security and economic infrastructure fortified.

What is not yet absolutely clear (even though institutions like the WTO are mentioned in the announcement) is the extent to which the EU will work with international partners like the US in terms of collaborating more closely on disrupting questionable financial flows for instance. This has been an area of technical weakness across the EU and embarrassingly many of flows of ‘bad money’ in and around the EU have been detected by the US.

In typical European style, this initiative is just a start. It is porous and easily circumnavigated, to stick with the Maginot analogy, but in the longer term points to even greater coordination across states, greater scrutiny of investment flows and I hope, greater collaboration across countries.

Have a great week ahead,

Mike

A couple of interesting events happened in the venture capital industry last week, that tell us much about how capital flows, and the impact it will have on our society.

In Paris the Sista Fund investment conference took place, the aim of which is to focus attention on the need for the venture industry to provide capital to female founders, and additionally to support female investors. Some of the statistics flagged at the conference are startling –across Europe just 7% of start-up funding goes to female-founded start-ups, and for larger growth companies, less than 1% of large funding tickets (Eur 50mn and more) went to all-female founders in 2022.

Then, in the UK, the Black Seeds fund – a VC fund designed to raise capital for black business founders in the UK raised a total of GBP 5mn. Sadly, this is a miniscule amount of money compared to the size of funds across the industry, not to mention the amount that is wasted on projects of pure fantasy (for a more informed view on this please see the excellent Sinéad O’Sullivan’s recent articles on space and crypto funding in the FT).

At the same time, four French ‘AI bros’ whose new venture Mistral.AI has only been up and running for four weeks received some Eur 105 mn in funding for their venture at a valuation of Eur 240mn. Given the difficulty of raising funds at the moment this is an impressive raise, reflecting both the background of the team and the eco-system of state, business, media and entrepreneurs they have backing them, most of whom are French, highlighting the highly ‘networked’ side of French business.

However, that Mistral.AI can raise Eur 105mn in a few weeks, and Black Seeds takes in only USD 5mn, and no-one is willing to give have the ‘better’ half of the population investment capital, is not a good thing. On one hand it shows how capital gravitates faddishly to the prospect of financial return rather than economic return, and it also shows that while the majority of VC funds and investors wrap themselves in the banners of sustainability/equality and ESG, they are shy of committing real capital to these causes.

In an age where developed countries want to attract qualified migrant workers, and where productivity gains are in short supply, ‘diverse’ (by which I mean ‘not AI bros’) founders need to be able to access investment capital.

A cynical response to the above development is for female entrepreneurs for instance, to cloak their projects in AI, and I suspect that this is already happening such that mind-numbingly, every pitchdeck contains multiple mentions of the word ‘intelligent’. A better piece of advice for VC funds and entrepreneurs is to follow the example of Mistral. AI and build an eco-system of government, corporate and entrepreneur supporters. The best VC’s that I know have done this.

Another angle of attack is AI itself, and specifically the data that various AI applications run on. Some years ago, I wrote about Joy Buolamwini’s Algorithmic Justice League that seeks to adjust algorithms for the biases they are programmed with. To be very speculative here, a corrective approach to AI could be taken a step further and have algorithms programmed exclusively by women, for application in female specific cases in industries like insurance and health, and to have guardrails also programmed by women. Such an approach might make the AI craze more responsive to different segments of society.

The impact of AI has already become an area of intense focus and last week the EU Parliament signed off the EU AI Act, whose main contribution is to divide the application into four pillars from harmless to very harmful (akin to China’s use of AI for social credit scoring). There has been some backlash against this already from businesses across multiple sectors that apply AI and who may find themselves being classified as AI companies (and hence liable to the regulation).

The other group to protest is unsurprisingly, the French AI bros, who fear the Act will crimp their creative flair. With a growing number of Emmanuel Macron’s former ministers joining VC firms and start-ups, I fear the AI bros might win again.

A quote I often like to deploy comes from Jagdeesh Bhagwati, one of the leading policy ‘lights’ and advocates of free trade at the start of this period of globalization who said that American multinationals were the ‘B-52’s of globalization’. It was a fitting image for an economist who counselled the likes of the GATT and other world institutions to let free trade flourish, unrestricted by concerns over labour laws and whose main works were titled ‘Free Trade Today’ (2002) and ‘In Defense of Globalization’ (2004).

To his credit, Bhagwati’s view prefigured the domination of world commerce by US multinationals, that is until China’s own corporate giants rose. Today, the world’s largest companies are still mostly American, with a number of Chinese like Tencent, and a handful of Europeans. 

However, a new trend is occurring, which will involve many of those ‘B-52’s’ turning for home, or even changing their spots.

I had often wondered whether the end of globalisation and the fracturing of the world economy into a multipolar order would produce a similar rupture in global corporate business models. That such a rupture didn’t happen is testament to the agility of these companies, the digitisation of economies and the power of international brands.

Since Donald Trump took power, multinationals have had to deal with a trade war, the supply chain disruptions of COVID and the resulting rise of both the digital economy and working from home in the West. As if that were not enough, the introduction of robotics and machine learning to production processes, national security concerns and then the Inflation Reduction Act have pushed and pulled American companies closer to ‘home’ (with some friend shoring), and even drawn a few Europeans with it.

If the American corporate empire is well, then the British corporate scene is withering (recall that the East India Company was perhaps the first company to become involved in geopolitics – with horrendous consequences for India, please see William Dalrymple’s The Anarchy) as the consequences of Brexit push large companies to delist from London and move to New York or the euro-zone (one of the notable movers is CRH which with a business in nearly every European country and American state is not unsuited to a US listing). HSBC is of course another example where realpolitik has led it to move its centre of gravity to Asia. 

So to summarise, the international corporate response to a changing world has been to either change what is under the bonnet (supply chains, work and technology practices) or change ‘home’. Few of them have changed their ‘shop front’ or brand – which is the canary in the coal mine I have been looking out for.

In that respect, imagine my glee to hear that the giant venture fund Sequoia is to split itself in three – a US/European business, an Indian one and a Chinese firm called Redwood in the English re-translation from Chinese of Sequoia. While differences in local markets and investment styles may have contributed to this, the fact that American companies prefer Western capital than Chinese – and vice versa, will have been a factor, as will the growing scrutiny of service providers like investment firms and consultancies in China by the Chinese authorities. Sequoia is interesting as it has in the past shifted structure in response to a changing environment (nearly two years ago it effectively merged its individual pots of capital into a large pool).

The question now is whether Sequoia is the first of many brands to be hit by the geopolitical bug, and other brands splinter into regional varieties, or rather what industries specifically might be vulnerable. 

If I were a management consultant, I am sure I could make a great deal of money consulting firms on the geo-political transformation of brands, should this become a trend. For the time being I think we can differentiate between brands at three levels.

First, those where the brand is integral to the product and its allure and quality transcend geopolitics (LVMH, Rolls Royce and potentially Apple). Second, there are brands that identify with country brands (TikTok, US car manufacturers, many Japanese companies and some German car companies) and these may be vulnerable. 

Thirdly are companies that involve transfers of data, money and services (capital flows rather than trade flows) and I think the interesting disruptive factor here will not so much be that brands will need to change, but that underlying modes of corporate governance and regulation will increasingly diverge between the large regions. Whereas the initial effect of the ‘B-52’s of globalization’ was to promote an Americanised approach to finance, accounting and regulation across many emerging markets, this may change, to the detriment of Western service companies. 

Sequoia’s job is to spot new trends, let’s see if they are now going to lead one.

Have a great week ahead, Mike

The front page of the latest edition of Time magazine carries a warning that we are at the ‘End of humAnIty’ in the sense that AI will take over the world and potentially exterminate the human race. The good news is that Time magazine covers tend to be contraindications, and I am closely watching the share price of AI mania stock Nvidia to see if its share price is going to peak on the publication of the Time cover story.

Regular readers will know that we have treated the dangers of AI on a number of occasions (The Final Problem, Talos, and LevAIlling), and I suspect that the ultimate effect of AI could ultimately be to lengthen human longevity. However, while we sit and worry about AI led drone strikes on our cities and being chased by drone swarms, we underestimate the effect of machines on our bodies and importantly, on our sociability. I had two reminders of this last week.

The first was hearing social historian Miriam Nyhan (formerly of NYU) describe the transition in the economy of Cork from one dominated by Ford to Apple (6000 employees).

While Ford’s initial contribution was to change the way we worked (I have had the benefit of a tour of the Dearborn factory, the most impressive element of which was to see robots making cars), the automobile industry has also changed the way we live – notably in terms of how cities are structured and the amount of exercise we get. Then, Apple and social media in general have changed commerce and entertainment but have also left us with physical contortions (the hunched phone user) and even worse, social deformities in the sense that for the first time ever, humans no longer interact with each other in a solely human way.

The second insight was from Prof. Rose Anne Kenny (author of the excellent ‘Age Proof’) the founder of  TILDA (The Irish Longitudinal Study on Aging) that has tracked nearly 9,000 adults aged fifty and older, and covers all aspects of life — from sex to food, to physical and brain health, genetics, childhood experiences, friendships, finance and much more — to fathom how and why we age, and to resolve how we can live longer and better.

When we combine the changes to our lives from technology, with changes to identity and acts such as drug taking, we are on the cusp of the most dramatic change in human behaviour ever. We can live for longer, but in many instances, we are not living better. What is clear is the degree of flux around our bodies and minds – from longevity to the atomization of societies, the diffusion of identity, and radical changes in average body shapes.

I don’t have a clever name for this epochal transformation – perhaps  ‘The Great Regression’ – but we might date it as having crystalised in the post COVID period when the combined results of all of these factors came together.

This is characterized by a number of factors – generalized longevity across the world with worrying regressions in life expectancy in specific economies owing to a combination of obesity, cardiovascular diseases, drug dependencies and depression. The US stands out here where life expectancy has dropped (see America’s periphery problem) precipitously to 76 years, its lowest level in over two decades (for reference Canada is 82 years and Japan 85).

In the future, these changes will be complicated by a range of factors, notably where morality and money are concerned. Wealthy people will try to access longevity (but perhaps not happiness) and advances in genetic engineering may open up an entirely new vista for the rich to grow and transplant organs or to design their ‘next generation’.

Then, AI broadly has the ability to help diagnose many illnesses depending on countries’ ability to collect good data, but where it is introduced into social welfare systems, may act in a cruel way to exclude people with say cardiovascular complications from getting insurance or social welfare.

As a final point, the striking aspect of Rose Anne Kenny’s work is that healthier and happier, long lives are essentially a function of good design – of cities and towns, healthcare provision, social education and diet (note that the journal Public Health Nutrition shows that ultra-processed food makes up over 45% of household purchases in Ireland, the UK and Germany as opposed to less than 14% in France, Italy and Portugal).

For that reason, I have a lot more confidence in the future of European democracies than autocracies or the Anglo-Saxon socio-economic model to successfully manage the enormous changes taking place in our bodies and minds.

Have a great week ahead,

Mike

I was once told a story by a reliable source (the story is too good to bother verifying) that in the late 1980’s at a summit of European leaders, Greek prime minister Andreas Papandreou arrived by car in the courtyard of a sumptuous hotel. As he stepped out of the limousine, the windows of a suite on the fourth floor of the hotel were flung open and appeared Charles Haughey, Taoiseach or prime minister of Ireland, who at the top of his voice declared ‘Andreas Papandreou, you are my hero!’.

In many respects, Haughey was right, he and Papandreou were very alike – clever and corrupt, leaders of large grassroots political parties (political scientists compared Fianna Fail and Pasok, the party Papandreou founded, as the most enduring political machines in Europe).

Haughey and Papandreou both had interesting personal lives and tastes – Haughey in his grandeur sent the bill for 14,000 pounds (a lot of money back then!) worth of Charvet shirts to the Irish state. Papandreou had been the Dean of the economics faculty at Stanford, but couldn’t manage the Greek economy, and later couldn’t manage his personal life. I had the pleasure to spend a lot of time in Greece in the late 1990’s, when the behaviour of Papandreou’s third wife ‘Mimi’ provoked a lot of debate.

Both men, it could be said, opened up the way for their countries to perform into the early 2000’s but both also sowed the seeds of the downfall of their economies in the post 2007 period. In both cases, what were dominant political parties have been reduced to much smaller players.

This much was evident in last week’s Greek election – while the share of the vote that Pasok held rose to 11% from 8%, it is a shadow of the machine it was. Kyriakos Mitsotakis the son of Andreas Papandreou’s political rival Konstantos Mitsotakis, has won an impressive victory and will likely do even better in a second election at the end of June, such is the apparent desire amongst Greeks for prolonged economic growth.

 As an aside, recall that in the dynastic environment of Greek politics George Papandreou, son of Andreas, took over Pasok as Greece headed into the euro-zone debt crisis – and to reinforce the notion of dynastic politics, George Papandreou was also the room-mate at Amherst of Antonios Samaras – New Democracy prime minister from 2012-2015!.

Having gotten to know Greece very well in the 1990’s I visited there during the ‘Troika’ period. There is simply not enough recognition of the devastation of the Greek economy and of its society, by Greece’s own excesses, the euro-zone crisis and the medicine applied by the IMF and EU. For a country that suffered the worst depression in modern history to now begin to enjoy consecutive years of strong growth is a very good thing.

Greek society and the way the country is run have changed though there are echoes of some of the things I recall from the news in the 1990’s – corruption in procurement and transport (witness the causes of the trains crash in northern Greece in February) and there are still bugging scandals.

The great challenge for Mitsotakis now is not so much to prolong the uptick in the economy – investors are already re-rating it (bond yields are below Italy and the UK) but to make decisive departures with the modus operandi of the past in terms of the way the state is run. The other glaring (to my experience) area for reform is education – notably in creating a much better secondary and tertiary education system so that young Greek people are happy to remain in Greece for their education and to then work there.

A new development for Greece is a change in the fortunes and behaviour of its larger neighbour. In the 1990’s there was constant tension between Turkey and Greece over both Cyprus and the small Greek islands close to the Turkish coast, resulting in frequent close contact between the Greek and Turkish air forces. Recyyp Erdogan took power just before Greece hosted the Olympics and for a long time the performance of the Turkish economy, the scope of its infrastructure building and its growing role as a model for Middle Eastern states put Greece in the shade.  

Turkey’s progress has been squandered, and its economy is now not far from a crisis. The worry for Greece is that Erdogan tries to create tension with Greece as a distraction from the consequences of his own long term in office. While the Greeks are used to this (both Mitsotakis and Alexis Tsipras have handled relations with Turkey well), it could be an unnecessary complication just when things are going the right way.

Have a great week ahead,

Mike 

I want to get rich, powerful and famous so I have changed the name of The Levelling to ‘The LevAIlling’, to reflect the growing mania around the deployment and power of artificial intelligence (AI). Readers can rest assured however that all the output on these pages is organic (I had tried ChatGPT a few months ago but was not impressed).

AI has been around for a while, as have its many dangers. In ‘The Levelling’ we wrote about how algorithms were both causing and provoking inequalities and social injustice. Last summer we flagged the very sinister example of how the Spiez Laboratory in Switzerland (see the Final Problem) one of whose specialisations is the study of deadly toxins and infectious diseases (located not too far away from the Reichenbach Falls), where scientists performed an experiment where they deployed an AI driven drug discovery platform called MegaSyn to investigate how it might perform if it were untethered from its usual parameters.

In short, MegaSyn produced nearly 40,000 designs of potentially lethal bioweapon standard combinations (some as deadly as VX). It is an excellent example of machines, unconstrained by morality (humans have willingly crossed this moral threshold), producing very negative outcomes. In another recent note ‘Talos’ we explored some of the emerging philosophical issues around AI.

Two aspects of the AI story that we have not yet mentioned are the stock market and the labour market, both of which will be greatly impacted by AI.

A sure sign that AI has arrived is that it is creating a stock market bubble. Since the start of the year, ten companies have driven the performance of the S&P 500 index, nearly all of whom have some form of AI business.

 In particular, Nvidia which seems to have been at the centre of multiple market bubbles (bitcoin, gaming, semis) is the lead play in the AI investment trend. From a valuation point of view the price of the company’s stock trades at 30 times the value of its sales (for normal businesses 3 times is quite pricey), which is not far off the valuation levels that have marked the top of ‘fads’ or bubbles. What we do not yet have is a broad AI bubble in the sense that even companies with a passing association to AI and its necessary infrastructure trade at bubble valuations. Similarly, markets have not priced in the intensity of competition between the big AI centric technology firms (Microsoft versus Google), not the disruptive threats they face from open source AI projects.

Much the same is true in the venture capital world, where AI funds and companies are one of the few ‘hot’ areas in VC. The popular ‘discovery’ of AI by the media is having a sizeable impact on the VC world in terms of providing the catalyst for funds to deploy cash to AI centric projects. Notably a whole range of companies is now touting their AI credentials, and slipping the AI moniker into their business description, in the same way that in 1999 companies adding a ‘dot.com’ surged in value.

In addition, companies reporting earnings, discussing their earnings on conference calls or even those appearing on financial TV (i.e. CNBC) will slip the phrase ‘AI’ into their dialogue so that this is picked up by AI driven analytics that in turn feed into stock buying programs.

If one popular reaction to a new innovation is that it will drive an investment bubble, then another is that it will fatally disrupt the ‘old world’, in the way that bitcoin was supposed to supplant the dollar and euro. In the case of AI, the promise is that it will cost us our jobs.

Labour markets have already been softened up in the past five years from ‘stay at home’ to the ‘great resignation’ to the ‘digital economy’, and they (in the G7) have arguably never been as robust. While there are some fields that are being disrupted by AI (the EU no longer needs 17% of its translators apparently) the best examples I have come across are where high performing humans – from surgeons to soldiers – use robots and artificial intelligence to do their jobs better.

While there is now a growing consulting trade on the future of the labour market (the WEF Future of the Jobs market 2023 report is a good starting point). One of the areas that is missed by many such studies are emerging market workforces -where regulation, social welfare and training levels are not at all as developed as they are in Europe for instance.

In some of the large emerging nations like India, training and education can be formulaic (I am not a fan of Byju as a firm) and could well expose knowledge workers in those countries to disruption by artificial intelligence. I belief that this is the great faultline of AI as it concerns labour, because if the effect of artificial intelligence on work is as great as many say, it could slow the natural path towards productivity and higher incomes of many emerging nations, the vast majority of whom do not have the industrial/capital base or expertise to build their own AI platforms (as Google is doing).

As it stands, there is also very little policy coordination between emerging nations, which again leaves them vulnerable in the face of AI. AI versus EM might become one of the great contests of the 21^st century.

Have a great week ahead,

Mike

A friend of mine has a very attractive theory about stockbroking, which is that the interaction between the investor and the salesperson is like the World Wrestling Federation (WWF), where like the professional wrestling matches everything is done for entertainment.

In stockbroking, fantastic stories are woven to investors in order to get investors to part with their capital, and impressive as the marketing performances are – it is generally understood by both sides that tales of ‘blue sky’ profits or impending doom are a fiction. It is of course easier to go along with this fiction when the (institutional) investor is investing other people’s money and not his/her own.

The WWF analogy, where colourful characters appear to do each other great harm is a generally very useful one, and specifically apt in the light of the debt ceiling debate that is warming up in the USA.

The debt ceiling stems from a provision in the constitution that states that only Congress can authorize borrowing on behalf of the US, and a 1917 act stipulates a limit on this debt (today’s limit is USD 31.4 trillion), that can be adjusted by consent of Congress. Today, higher rates complicate matters – the US spends more on interest payments than defence.

Presidents with a friendly Congress (for instance George W Bush received eight debt ceiling increases) do not need to worry much about this fiscal hurdle, however it becomes weaponized in the face of a ‘cohabitation’.

A good deal of the weaponization follows the WWF script, both sides huff and puff and take each other to the limit of pain, whence a deal is arrived at. Donald Trump, as an impresario (he was close friends with boxing promotor Don King, and at times part of the WWF theatre) understands this, recently telling CNN ‘the US should default….the Dems will probably cave’.

The debt ceiling debate has gotten a little out of control before. Memorably for investors in 2011 as the deadline approached, the US debt was downgraded by S&P from AAA to AA+, provoking a slide in markets. In 2013, the debt ceiling debate ran right to the limit, the personal highlight of which was when the late Senator John McCain tweeted a piece of research I had authored about wealth inequality (in Russia – he was spot on then).

There is no reason for the debt ceiling to be a market issue, except for perhaps four questions – the willingness of markets to participate in the WWF like theatre, the historic levels of bitterness across the American political spectrum, an amalgam of economic faultlines the most pressing of which is weakness in the US regional banking sector, and the venality of US Congressmen and women.

In short, we have the tinder and the sparks for this to go horribly wrong over the summer. The timing of any debt ceiling imbroglio will depend on the exact moment that the treasury runs out of money. Janet Yellen has stated that this could happen in early June but interest rate and money market pricing suggests close to July for a default event.

First, let me sketch three broad scenarios

Bi-partisanship (15%) – President Joe Biden, when he was a senator, was renowned for his bi-partisanship and the friendships he cultivated on both sides of the House. That era is gone now, and American politics is radicalized. Under current party structures, there is no incentive – absent an external threat – for politicians to come together and pragmatically pass a ceiling increase. That is why I grant this ‘grown-up’ scenario a low probability. Indeed, the only thing that might send the Democrats and Republicans rushing into each other’s arms is a banking crisis.

Chicken (70%) – in this scenario the Democrats and Republicans bicker till the last minute, with the Republicans trying to curb the spending power of the administration as a quid pro quo for voting the debt ceiling increase. The important element here is how complicit markets are – if we see a spike in equity volatility, a deepening of the credit crunch and loud warnings of the ‘end of the dollar’ and American financial hegemony, then a ceiling rise will be passed.

Having spoken to many people in Washington, I find them overly focused on the debt ceiling and not some of the underlying stresses in the US financial system – namely a credit crunch and a periphery crisis in banking. The risks could very easily become the real problem and dwarf the ceiling debate. Two other factors to note here are that a drawn out ceiling debate will result in less market liquidity in Q3 and an eventual deal might produce a minor, negative fiscal shock.

Cliffhanger (15%) – the risk here is that enough Republicans (i.e. McCarthy) are in thrall to Donald Trump that they are willing to do to America’s financial reputation what he has done to American democracy, and that a historic default becomes likely. Such a scenario is not as wild as we might have thought six years ago, but it would likely be preceded by the enacting of Treasury emergency financing plans and stern words from the Chair of the Federal Reserve. A formal default may not just happen, but it could come close.

In the context of the WWF thesis, the middle scenario is the best one – we all have a fright, are fantastically entertained and enjoy a happy ending. Financially it is the best one for politicians. Members of Congress face little to no restriction on stock trading and some of them (e.g. Dianne Feinstein and Nancy Pelosi have better trading records than many hedge funds and are known to be very wealthy).

For instance, a New York Times report found that between 2019 and 2021, 97 senators and representatives or their family members bought or sold stocks in sectors that could be affected by their legislative committee work. Readers might think this is an all too cynical approach on my part to suggest that Congress members have an interest in market volatility, but it does nonetheless accord with the WWF thesis!

As it stands, few have an incentive for the debt ceiling to pass quietly, and many want and need a spectacle. Prepare to be entertained.

In the next few weeks we may see headlines like ‘Is America Greece?; ‘is it Italy?. The headlines won’t refer to wine, food and culture but to banks, because America now has a periphery bank problem. In the past three months the index of America’s regional banks has nearly halved. The speed (witness the demise of Silicon Valley Bank) and scale of what is happening is worrisome. At the height of the global financial crisis some 150 financial institutions – with total assets of nearly USD 500 bn – ceased to exist, though today a handful of American banks have expired, with assets of close to USD 600 bn up in the air.

With politicians and policymakers in Washington focused intently on the debt ceiling, the risk is that a periphery (regional and community banks) banks crisis overwhelms the debt debate and produces the sort of crisis that is consistent with the end of every Fed rate hiking cycle. My ‘breaking things’ thesis on the Fed remains intact.

The regional banks crisis is largely one of confidence (most bank crises historically have been), of monetary policy and of banking practice. In all too simple terms, banks have taken in deposits and matched these by placing capital in the Treasury market. As interest rates and inflation rose, the value of these Treasuries fell, thus reducing the capital available to banks should depositors want their money back.

The problem now is that depositors want their money back. Some of this is flowing to money market funds in order to avail of high interest rates that the banks do not offer. Social media and financial cable tv have not helped induce a sense of calm either.

Europeans of course have seen all this before, though our problem was one of the structure of the monetary system, in the context of a brittle banking system. Since the euro-zone crisis, a good deal has been done to bolster the euro-zone monetary system, but very little to advance capital markets and banking union. Looking at the USA, Europeans will also recognize the brutal way in which market stress leads policymakers to reverse policy rules put together in calmer times, to rush to provide market liquidity and to predictably blame speculators (they are not without blame but are not the root of the problem).

From here there are two risks for America. The first is that many of the policy measures that should induce some faith in the banking system (generous deposit guarantees, a liquidity provision mechanism (the BTFP)) are already in place, so that in the absence of a new broad program of support for the regional banks (that would break many of the rules of financial policy making), the pressure on the banking system persists and could unravel into a full-fledged crisis. Some of the underlying conditions in the US banking sector – such as a weak commercial real estate sector and a sharp drop in lending are a concern.

What is more worrying are the enduring effects of the decimation of America’s periphery banking system – there is a credit crunch going on in Silicon Valley and beyond that will also lead many venture firms to write down the value of investments. Then, in other parts of the US, individual states will be hit by the consequences of weaker regional banks, the shift of deposits towards behemoths like JPMorgan may mean that the costs of banking are higher.

This shift in capital from periphery to core mirrors a deeper trend in the US, which is that in terms of its society, economy and financial system it is becoming pyramidical, with a successful core at the top of that pyramid and a very large base or periphery.

Wealth in the US is highly unequal – 35% of all wealth is held by the ‘top 1%’ a high for the developed world and a figure that is exceeded only by emerging nations (India, Russia and Brazil). For comparison, in Canada the top 1% own 25% of total wealth. The wealth outlook in the US reflects in part the growing concentration effect in the stock market (the top five technology companies make up close to 25% of the market capitalization of the stock market), and now in the banking system.

It may also reinforce a narrative that American politics has become a system that favors insiders (core) at the expense of outsiders (periphery), and in terms of other markers such as the quality and provision of education and healthcare, and metrics like life expectancy there is a significant difference between the core and periphery (there can be a difference in life expectancy of up to seven years between ‘mid’ and ‘southern’ states like Mississippi and wealthier coastal ones like California and New York). More generally, overall life expectancy is plummeting in the US, at a rate only seen in Russia around the fall of communism. 

In that respect, deposit flight may reflect the innate fears Americans have about their country, and this is a warning sign for a much deeper malaise.

Have a great week ahead,

Mike

Hidden away in Jan Werner Mueller’s book on populism is a gem of a quote from Recep Erdogan ‘We are the people, who are you?’ It is a powerful, defiant statement from a politician who has become the embodiment of Turkey – first by seducing its people with progress, growth and national achievement, and more recently by capturing the state – breaking and denuding its institutions, and as a result of his actions and values, annihilating its economy (inflation has pushed close to 100%).

Erdogan will become a central figure in the news in coming weeks. While there are no major elections in G7 countries this year, the Turkish presidential election (first round is on the 14^th May) is important internationally for a range of reasons.

It is a decisive pivot point for Turkey, which is clinging to democracy and to the notion of a stable economic structure. A victory for Erdogan will quench that democracy and arguably cause those who still have hope for its economy to throw in the towel. It might dim forever the example of Kemal Ataturk that Turkey should strive to be secular, democratic and lean Westwards.

More broadly, Erdogan is a test case in the ‘autocratic-recession’ thesis – populists like Bolsonaro, Boris and Donald Trump have been derailed, and a change of guard in Turkey would mean that one of the longest standing populists has been rejected, and that Turkey’s democracy might again breathe.

Geopolitically the election is highly significant. There was a time when Turkey was admired as a role model and force for stability in the middle east (notably so in the aftermath of the Arab Spring) and its foreign policy maxim was ‘no trouble with neighbours’. As we have noted in this previous missive, Turkey is enmeshed in conflict at every point of the compass – stuck in the Azerbaijan-Armenia conflict, active in Libya and Syria, at odds with Israel, the most obstreperous member of the NATO alliance and a ‘frenemy of Russia. Simply put there is a lot at stake.

Standing against Erdogan is the veteran politician Kemal Kilicdaroglu – who has been leader of the Republican People’s Party since 2010. He is an economist and civil servant by background and generally regarded as mild-mannered though in recent weeks he has led demonstrations outside the offices of ministers. This is partly because the ante has been upped by the political consequences of the earthquakes which led to 50,000 deaths.

Not unlike the fatal derailing of a train in north-eastern Greece, the human toll in the Turkish earthquake is recognized to stem from the consequences of corruption – either through shoddy engineering or in the failure of Turkey’s institutions to provide help to the stricken.

Erdogan – despite being a career politician is widely thought to be a billionaire, and he as members of his family are derided as ‘Mr 10%’ is some quarters (the original Mr 10% was – allegedly – Benazir Bhutto’s husband who it was said took a fee of ‘10%’ of every major contract in Pakistan).

I have heard people that the same holds in Turkey. Whether this is true or not Turkey is the example I always use to illustrate the negative effects on bond and currency markets of the weakening of institutions (Erdogan’s family and close allies have for example controlled the treasury and central bank).

In this regard, Turkey is a salient tale in the rise and fall of nations. Since the early 2000’s when Kemal Dervis had righted the banking system and the prospect of membership of the EU was dangled in front of it, Turkey made great progress. Lately this has come to a halt as policy making, the quality of institutions and the rule of law have been degraded.

Ironically, the authority on the importance of institutional quality and the need for a sense of civic ethic is Daron Acemoglu (the author with Simon Robinson’s of ‘Why Nation’s Fail?, and they have a new book called power and progress out soon).

Acemoglu, like Dani Rodrik, is one of the leading economists in the world, and Turkish. Both of them I am sure, lament the direction that their country has taken, and both would have clear policy answers to set it back on course.

To return to the election, Erdogan’s latest rick is to ‘pull a sickie’ and cancel campaign events in a move that some insiders say is an attempt at a sympathy vote. My sense is that should the first round of the election be close then Erdogan will go into full populist mode and enact the Trump play card – claiming a conspiracy by the army, outside forces and potentially, a rigged vote. The fate of the mayor of Istanbul, in jailed for speaking out against the Erdogan government, is a sign of how far Erdogan is prepared to go to safeguard his position. A good deal also depends on the cohesiveness of the opposition parties in the face of an onslaught from Erdogan.

Defeat for him would ripple across emerging markets, Ukraine and the middle east.