There is a scene at the end of the film ‘The Firm’ where the character played by Tom Cruise is chased along the Mississippi bank in Memphis. As we might expect, our hero escapes. I was in Memphis recently, and ‘re-created’ the run along the mud bank, and then across the Harahan bridge into Arkansas – which looks very much like Tennessee, and no sign at all of Bill Clinton.

In my visit to Tennessee one private objective was to pick up a sense of the fractured political climate in the US ahead of the midterm elections – though disappointingly all the people I met were pleasant, intelligent and well informed. On then to New York, where at a breakfast meeting, I spotted Bill Barr at the next table no doubt conspiring on the election with a Republican Senate candidate.

Then, a quick, regular homage to the tomb of Alexander Hamilton (see chapter ten of the Levelling) before a meeting in the new World Trade Centre. The last time I was there, I shared a podium (one the very impressive top floor) with JD Vance, author of HillBilly Elegy, and now a Senate candidate in Ohio.

At the time – I had greatly enjoyed his book – my impression was of someone who was authentic, somewhat unpolished and with strong views. I recall him being very critical of Donald Trump. Since then, Vance has been swallowed up in the bitter morass of American politics, and viewed from Europe, been radicalized. This is a pity given his life story and achievements, but emblematic of the intensity and complexity of public life in the US.

It was always a testing environment – an examination of the period Hamilton lived through (and the fact that he died in a duel), highlights the vitriol of the press and political debate back then (Ron Chernow’s book is a good reference point). There is also a school of thought that holds that the quality of politicians has been on a downward tack since the Founding Fathers, Andy Borowitz’ new book is an example (‘Profiles in Ignorance’).

Against the backdrop of the ebb and flow of the fortunes of strongmen leaders (Bibi is back, Bolsonaro is out, Boris is on tour) and the context of a worldwide democratic depression, the mid-terms are interesting for what they tell us about the theatrical aspect of American politics (notably the Pennsylvania race between Dr Oz and John Fetterman), the pulling power of Donald Trump and the health of American democracy.

In that respect, the barometers to watch are the relative success of ‘non-Trump’ Republicans (for example Doug Ducey in Arizona or Joe O’Dea in Arizona), the extent to which candidates at the extremes of both parties do well (worryingly both Kevin McCarthy and a group of left wing Democrats including Alexandra Ocasio-Castro have tried to suggest that America’s support for Ukraine be limited).

Listening to the debate, it seems that the notion of ‘truth’ is very much up for grabs, both in the sense to which candidates and their supporters have flexible views on the rules of the political process, and to the extent to which they feel their own lives need to correspond to their policies – Herschel Walker the former Dallas Cowboys running back and now Republican candidate in Georgia is a case in point in terms of his stance on abortion.

The race will also give a steer as to the runners and riders in the 2024 Presidential election – I suspect that on balance the Republicans will do relatively well in the mid-terms (a barometer of the extent to which Americans care about the economy versus abortion for instance), and Donald Trump could claim credit for this and declare his candidacy for the Presidency (he is, statistically, the most ‘losingist’ President since Herbert Hoover having lost the Presidential election and the Senate and Congress).

It is not clear who the Democratic candidate might be – officially Joe Biden is a contender and problematically for the Democratic race there are few other obvious contenders (maybe Mayor Pete?). My own view is that the really interesting political figures are found at the mayoral and gubernational levels – Mike Duggan in Detroit and Francis Suarez in Miami.

In previous decades, a relatively good mid-term for the Republicans would have fostered talk of bi-partisan cooperation with a Democratic President – something that Joe Biden excelled at during his career. This time is different. The battle for American democracy may just heat up.

During the week I participated in a discussion with a group of insurance sector executives as to what defines ‘at war’ – in the context of various claims on the sector with respect to the invasion of Ukraine (i.e. ships stranded in the Black Sea, aircraft impounded in Russia). The question is an increasingly relevant one, notably for the evolution of security policy in Europe.

In recent days, at least two developments have underlined this. One is the elevation of Xi Jinping to a third term as Chinese leader, in a choreographed display of singular ‘thoughtcrime’. In my view the transition from a ‘one party’ to a ‘one man’ state may not necessarily make the invasion of Taiwan more likely, but it does increase the risk of policy mistakes by China (as an aside, capital is trying to flee China and, the Chinese stock market has delivered a 30 year return of precisely 0%).

The other was the repeated warnings from Russia that Ukraine is developing a dirty bomb – such crooked veiled threats can be unlocked by turning them upside down – Russia is signaling its intention to escalate the war in an even more ghastly way (interestingly this week’s Der Spiegel has an interesting article on veiled threats by Russia to attack Berlin with nuclear weapons). 

And, the Russians have been busy. Consistent with some of our earlier missives (From Great War to Total War) Russia has adopted a policy of aggravating and irritating Europe around its borders. They have now stepped this up to menace critical infrastructure – cyber attacks on banks, transport companies in large European countries, the (alleged) blowing up of gas pipelines around the Nordic states, the threat to vandalize telecommunication cables linking the US to Ireland (and thus Europe). It is a ruthless, near medieval siege type attack where Europe’s vital connections are targeted.

Not to mind that, but attacks are coming in other domains. In a recent note (The Man on Horseback) we noted the epidemic of coups d’états in African states, many of which coincided with the arrival of the Russian mercenary firm Wagner in those countries. There has yet to be a push back from the colonial power in many of those countries (France) but it could come once the outcome of the war in Ukraine is more clear.

In sum, Europe is under attack, if not at war. Insurers would argue that the technical conditions for war are not met, but the reality on the ground is that this is the case in a practical sense. This attack or aggravation by Russia may also mark the first time that Europe as an entity or more importantly, as a system of values, is under attack. How then might it respond?

First, in some European countries, where a coherent security policy has been willfully neglected because of historical factors, there is a rude awakening.

Germany is a good example and it has a long way to go in replenishing its military hardware and personnel. Indeed, one of the reasons for the relatively difficult relations between the German and French governments has been the German reluctance to buy French weaponry. If that’s not enough, Germany is also caught in a difficult position with regard to Russia’s ‘unlimited friend’ China, with a proposed Chinese acquisition of Hamburg’s port and a visit to China by Olaf Scholz stirring controversy.  

Ireland is another example, where complacency regarding its geographic location and a half-baked policy of neutrality have been conceived in a way that it is effectively defenceless – so much so that when a Russian plane flies close to Irish airspace, we need to call the RAF. Irish politicians may think that its location and neutrality render it safe, but viewed through Russian eyes Ireland is a tributary of the larger Anglo-Saxon countries (notably the US) and an easy candidate for a provocative act.

Second, at some point, Europe’s leaders will feel the need to respond to aggression, and in the pattern of the EU being forced to evolve by crises, it may for the first time undertake an offensive action in the name of the EU. This would take the EU into a highly ambiguous area, and such an act may take the shape of a coalition of the willing – perhaps a large scale cyber attack led by the Netherlands, France and Sweden. 

The awakening that Europe is under attack should really sharpen the view that cannot suffer attacks from within – I have written many times on the need to credibly sanction Viktor Orban’s Hungary. Additionally, the progress of countries like Serbia towards EU membership should be halted. Moreover, Belarus a weak point in Russia’s constellation should be more actively targeted in terms of sanctions and support for its pro-democracy movement.

This has not been an optimistic post, but to finish on a high, though stay on topic, I can recommend an excellent, amusing collection of the writings (between 1940-45) of Flann O’Brien, entitled ‘At War’.  

It is hard not to write about the end of the short political career of Liz Truss, harder still to say something funnier than the array of jokes already printed, and impossible to write about the dangerous political asteroid that is Brexit.

Truss’ exit is the logical outcome of the Tory party’s hatred of Europe on one hand and inability and unwillingness to arrest their country’s relative decline, that has consumed British politics, troubled the EU, permanently damaged the UK and likely destroyed the Union. This bonfire may only end when the Tory party itself is consumed by Brexit, and this day may not be far off. Even with a new prime minister, in the context of severe economic stress in the UK we cannot be far away from a general election, which based on opinion polls, would effectively wipe out the Tories.

Truss’ premiership will go down as the worst and shortest in British history, competing with the likes of George Canning who died after 121 days in the role, and Andrew Bonar Law who stepped down with illness after 211 days. Even, Edgar Æthling who ruled England from October 1066 till William the Conqueror stepped in in December 1066, lasted longer.

Equally, Truss will make Lord North (who lost the American ‘colonies’) and Anthony Eden (Suez) look like strategic geniuses.

That the current cabinet is now made up largely of ‘Remainers’ and the political-economic landscape in the UK is in ruins, support the sense that Brexit was a bad idea. That some Tory MP’s and party members still want Boris Johnson as prime minister suggest that pockets of denial remain, and that more ‘pain’ is necessary.

Brexit allowed the most ambitious, least able politicians to come to the fore, and it is time to now reverse this. One recent example of the clash of ability with politics comes in Kate Bingham’s recent book ‘The Long Shot’ where she details the race to find and distribute a COVID vaccine in the UK, and the political machinations involved in the process.

The implosion of the Brexiteers allows many people to say ‘I told you so!’, and I am going to clamber shamelessly onto this bandwagon. It could have been very different.

Some four years ago when I wrote ‘The Levelling’ I created a character called Katherine Chidley. She was based on a very impressive 17th century activist and businesswoman of that name. Born in 1616, Katherine Chidley was one of the most eloquent and prominent women in public life in mid-seventeenth-century England. She wrote widely, ran a business (selling socks to the army) and was the mother of seven children.

In the book (chapter six – much of what follows is directly from this) I imagined a modern politician in her image, newly elected, and thrown into the position of finance minister. As such her aim is to find a formula for sustainable economic growth that will also lead to a balanced society (Liz Truss could have taken this path but didn’t).

Chidley is determined, especially to avoid creating imbalances in debt levels, asset prices, and trade. Minister Chidley has many obstacles ahead; the first is coming to grips with her department and with the nuances of economics and finance.

‘As the new finance minister she might, if not careful, find herself being quickly carried along in the jargon of economics, speaking in terms of deficits and the code of GDP forecasts. Like most professions, finance and economics have their own codes, rituals, and language. To the outsider, most of this is dull and hard to comprehend (even Kwasi got it wrong).

In her first weeks in the job Chidley will see economics and policy making from the inside and will make a journey of discovery, learning to distinguish cosmetic drivers of growth from longer-term, more meaningful factors —such as a focus on investment in human development. They take time to show dividends but are ultimately the ingredients that make countries strong and resilient.

In her first few days in the job, she asks her chief civil servant or “Sir Humphrey” to give

her an honest view of the lay of the land: What is the outlook for economic growth, where does economic growth come from, and, optimistically, how can she improve her country’s level of growth?

An honest mandarin might point out that economic growth, as we have come to know it, is getting scarcer and more constrained. In order to soften that blow the mandarin might heave a great pile of research and policy papers from institutions like the IMF, the World Bank, and OECD onto the desk of Minister Chidley.

Already, Minister Chidley will see that a troubling pattern is emerging. At one level, we see the slowing and transformation of globalization. At another, the end of a very long economic cycle is in sight. There is also a sense of exhaustion, not merely on the part of households and businesses but also on the part of policy makers, especially central banks, who have gone to extraordinary lengths to sustain growth and prevent a deep recession (and who are now confronted by high inflation). This exhaustion may be attributable to the fact that at no point since the late 1990s has there been a full-scale reckoning or  clearing out of the imbalances in the world economic system.

Having listened to this long tale of lower growth, the economic handbrakes of demographics, and lower productivity, Minister Chidley is thoroughly depressed and wishes she had been made a minister of defense instead. Tackling low growth and its consequences will be demanding.

She has two, perhaps three, options. First, worried that there seems to be very little public acceptance that the future could be less rosy than  the past, she asks her mandarin for a quick fix, an economic magic pill.  An infrastructure program like Boston’s Big Dig might fit the bill. A second option is economic nationalism. With the level of growth likely to be lower than it has in the past twenty years, she might take to megaphone politics, point to growing competing economies and tell her voters that she will take back the growth that is theirs.

Third, and the difficult solution practically and politically, she might ask what drives national development and stability in the long term and set about creating a framework to implement those drivers. She is drawn to the idea of country strength, which relies on nations’ developing a policy mind-set that cultivates economic resilience and that invests in intangible infrastructure (education, an inclusive society, research/development, institutional excellence).

Katherine Chidley, and the economic vision that she developed, which I set our four years ago is the anti-thesis of Liz Truss. The only remaining question is how much chaos the Tories must visit upon themselves and their country, until a Chidley character takes the political stage.

I am being a little lazy this week in that I am serving up ‘one I made earlier’. Following a week where economic policymakers gathered for the annual meeting of the IMF and World Bank, Christos Cabolis (chief economist at the IMD.. in Lausanne) and myself have an article in the excellent Prospect magazine, where we look forward to the kinds of institutions that are needed to marshall the world order of the 21st century. 

It says much about the defunct nature of the IMF that they have little relevance in a world where markets appear untamed (equities had one of the largest turnarounds ever last week, whilst the volatility in gilts is mind boggling). It would be easy to spend time castigating the likes of the IMF and WTO (World Trade Organisation), but I have done that many times before (and also at last week’s Global Goals conference). 

Instead, its is better, we feel to try to start a debate on the kinds of institutions that will be required to police cyber warfare, give institutional structure to new forms of money and even, produce meaningful climate change. 

Hope you enjoy the article – I attach a link here and the text below. 

The Queen’s death reminds us that an era of stability has come decisively to an end. We are currently facing a number of global shocks—a sharp breakout in inflation and a corresponding rise in interest rates, a bloody war in Europe and rising tensions between China and the US, the two largest economies in the world. Longer-term issues such as climate change, declining productivity, rising indebtedness and extreme income and wealth inequalities in the wake of the financial crisis leave us in no doubt that the world has changed.

We now must focus attention on the institutional infrastructure required to marshal the world order of the 21^st century. Many of the institutions that were established to mediate the post-World War Two order are now defunct. Even those that fulfilled the roles that were intended for them may now have nothing more to offer.

The World Bank is such an example, especially in the context of economic growth across Asia and the rise of rival sources of funding (e.g. the Asian Development Bank.)

[Also should draw attention to the fact that the “stability” of the 20^th and 21^st centuries was not necessarily relevant in most parts of the world – Yugoslavia, Eritrea, Congo, Syria, Iraq, Afghanistan etc – not quite relevant here in my view

Another Bretton Woods institution, the International Monetary Fund, is experiencing a decline in its credibility and influence. Notably, two of its major, recent funding programmes—for Argentina and Greece—have been severely criticised. The World Trade Organisation has been powerless and largely ignored in the face of trade wars. All three institutions have had multiple crises of leadership. The same is true of the World Health Organisation, which has allowed itself to be compromised by geopolitics during the most severe international health crisis of recent times.

These institutions are now largely obsolete, and any debate that seeks to resurrect them is a waste of time. More effort should be spent on identifying the policy challenges of the 21^st century and mapping out the institutions that can address them.

We must consider which powers, actors and countries are likely to shape the new world order. During the most recent wave of globalisation, power was rooted in the role of the USA as the dominant player, and indeed many of the world institutions were themselves rooted there—the UN, World Bank, IMF, with others based in European cities (WTO and WHO in Geneva and the OECD in Paris).

The new, multipolar world will be one dominated by at least three large regions—the US, the EU, China (the India-Dubai region is a potential fourth pole)—who do things increasingly distinctively, from their socio-economic models to internet regulation. These will be composed of groups of small advanced nations (the Nordics, Ireland, Singapore, Switzerland, Netherlands, New Zealand, Belgium and Switzerland) that top a range of league tables from democracy to innovation to human development, then a group of disparate non-superpower powerful countries (the UK, Russia, Japan, Australia, and possibly India), [I don’t follow the order of these groups here – is there a reason the small nations would be followed by larger ones? – I think the super powers and the small states are the most coherent, focused ones that’s why I have prioritiesd followed up by a group of emerging economies with large, fast-growing populations (e.g. Ethiopia, Indonesia, Kenya, Nigeria, Vietnam).

The needs and aims of these groups and nations, together with the ways in which they respond to new threats to security, will determine what the next set of institutions will look like and where they will be based. The new challenges of the future—climate change, potential energy shortages, and economic volatility, coupled with new technologies—will necessitate collaboration between them and other stakeholders, such as corporations. This will in turn demand global governance, new standards and regulation, and coordination through new institutional bodies. New world institutions or collaborative arrangements will need to be hammered out. What should they focus on and what might they look like?

Economic:

We now have the highest debt-to-GDP ratio in centuries. As inflation forces interest rates higher, it may be too late for an international institution (like the IMF) to gently persuade countries to reduce debt levels. But it is crucial that there is an institution that can oversee the chaos that may result from a new debt crisis. This body—a debt conference—would have at least two objectives: coordinating debt reduction and forgiveness across the major economies, and then putting in place a new set of “rules of the road” that will set in place new tenets of economic governance.

Meanwhile, questions over the “future of money” have gathered pace—turbocharged with the rise of crypto currencies and the steady advance of central bank plans for digital currencies. This new trend will necessitate the laying out of standards for payments and the technologies that drive them. It will require bodies that can oversee the intersection of centralised and decentralised money systems, and that help to order the spread of competing payment and money services across emerging countries.

Health and science:

Advances in medical research, in particular gene-editing technology, raise important ethical questions about the ways in which scientists can alter our genetic makeup. This could exacerbate health inequality, enabling the wealthy to live longer, at a higher health quality. In extremis, this may even raise the prospect of genetically edited athletes and soldiers. Where technological advances outstrip debates in law and philosophy, there is a need for global standards and laws to marshal this development.

The coronavirus pandemic has been remarkable for the innovations it has spurred in medicine and medical practice, and for the attention it has focused around mental health issues. This shift in emphasis is also percolating through national policy agendas, though mostly in smaller progressive countries— Iceland, Scotland and New Zealand have joined together to form a “Wellbeing Alliance”. With global poverty now significantly reduced from decades past, mental health is the next great frontier in health policy. It requires a global approach to co-ordinate best practice, diffuse this to the many countries that do not place mental health at the centre of their health services, and in particular to work with actors like corporations to improve the mental well-being of workers.

Cyber:

An increasingly common phenomenon is the disabling of healthcare systems, energy infrastructure and public services by cyberattacks. Many such attacks originate from Eastern Europe and especially Russia. The Baltic states, Ukraine, Syria, Turkey and Taiwan have all been targets for cyberattacks in recent years, not to mention the prominent cyberattacks by Iran as part of its “soft war” military strategy. Cyber-crime and cyber war occur in a grey zone in international law where there are no formal rules on how to punish cyber attackers who operate within a particular country. It is not clear whether a cyber-attack on a French hospital that originates in Lithuania that indirectly results in avoidable deaths, for instance, can be considered an act of war that permits a direct physical military response. Some corporations have already opened a debate on the need for legal infrastructure to deter cyberattacks, be they by state or private actors.

Climate:

That the world is enduring severe climate change is now incontrovertible. The 2015 Paris Accord is a formal acknowledgement of what must be done to combat it. In our view, nation states have not yet solved the game theoretic problem of producing a framework that aligns the cost and responsibility for climate damage. An international institution with carbon and levying powers, or even a framework agreement between large international cities, may offer potential solutions.  

Rare places:

One trend that become more apparent in recent years is the contest over distant locations that are difficult to reach, such as outer space or the Arctic. The US, Europe, Qatar and China have all sent probes to Mars. Space commerce, space defence and space tourism are set to grow. The invasion of geopolitics into largely inaccessible places raises the risk that these areas become contested, and that subsequent competitive behaviour become disorderly. While bodies like the Arctic Council already marshal the various interests acting in the Arctic, we envisage that a constitution will be necessary to oversee space exploration, space combat and space tourism.

We speculate that these areas, and the potential new institutions that will shape and shepherd them, will form the contours of the “new world order” that many talk about. Unlike the 20^th century, the engineering of these institutions cannot be left to governments alone but must involve corporations, cities, citizen assembly bodies and universities. At a time when the old world order is crumbling, these institutions offer an exciting opportunity to build something new.

One of the more remarkable places I have visited is the ancient fortress of Bam, in south eastern Iran – hidden behind high walls, there is initially little sense of the magnitude of this citadel, which in its full vista looks almost like a film set. I was lucky enough to see it just before it was destroyed in an earthquake, though it has now been largely reconstructed.

At the time, in the post 9/11 world, Iran had been castigated by George W Bush as part of the ‘axis of evil’, though it managed to use the war in Iraq and the eruption of the Arab Spring across Syria to deepen its tentacles across the Middle East.

My sense of Iran then was that for many of the things we believed about Iran from a Western point of view, the opposite was true, and I suspect that this is still the case, especially with respect to Iranians themselves. Iran has a very deep and rich heritage, matched by an enduring modern middle class and broad level of education across its population.

It is however, tightly controlled by a small, inward looking and harsh theocracy, aided and abetted by the Revolutionary Guard who exert de facto control over the Iranian economy as well as other sectors.

Iran has for many reasons been the centre of geopolitical intrigue – which is one reason why the Iranian state is structurally distrustful of Britain and America – and today, it is the locus of an increasingly open ‘secret’ war with Israel.

Against this complicated backdrop the protests across Iran by men and women, that were triggered by the death of Mahsa Amini, are important. In essence the protests were triggered by the new president Raisi’s desire to enforce strict Islamic decorum by increasing the number and vigour of the morality police.

In a country with a very large young population that has a hunger for a more progressive society and where there is a growing gender consciousness (the film the Stoning of Soraya M. is not only a good film but also a reminder of how the odds were stacked against Iranian women), such a repressive measure was a bad idea.

Over 100 people have now died in Iran since the murder of Mahsa Amini. While protests are widespread and frequent across Iran this one may have an enduring effect. One is that Iran’s supreme leader Ayatollah Khamenei is in poor health, and while a changing of the guard may not yield a reformist minded leader, he might be more pragmatic. Second, the ‘headscarf’ protests could feed broad public civil disobedience (women might stop wearing head scarfs altogether) that might then set in train broader social changes.

It is unlikely however, to produce what some call ‘regime change’ – the Iranian state is far too repressive to permit this, and there is sufficient paranoia and nationalism in Iran that any attempt at regime change would be perceived as an outside intervention in Iranian affairs.

The prospect of a slightly more modern Iranian state throws up an intriguing dilemma for those negotiating the Iran nuclear deal (JCPOA), which is now on its last legs. Do they do everything possible to ‘break’ the Iranian regime, or risk allowing a deal and the easing of sanctions that might open up Iran’s economy and society?

Whilst Israel will have a very powerful voice in these deliberations behind the scenes, recent events in Saudi Arabia may also become a factor.

Saudi Arabia’s very public cutting of oil production in tandem with Russia is effectively a ‘rogue’ turn by them, given the military and geopolitical support they have enjoyed from America over the years. Not only is Iran the polar opposite of Saudi Arabia socially, but it has hitherto been on the opposite side geopolitically. It is too much to say that Saudi Arabia’s alignment with Russia (Iran is a close partner) heralds a decisive shift in the geopolitics of the region, but this week there is a sense that long standing relationships are beginning to break down.  

Have a great week ahead,

Mike

In the House of Commons, when members of Parliament become rowdy, the Speaker will often bellow ‘Order, Order!’ Much of the same treatment is needed for gilts and sterling, both moving in a violent manner that historically has typified the breakdown of an economic regime.

There are several lessons to be learned here – one of which is that when making policy there is a need to be cognizant of the broader economic and financial environment. A financial climate troubled by inflation, rising interest rates and dangerous geopolitics is not one in which mistakes will be tolerated.

The early schoolboy/girl errors of the Truss government mark the cumulative effect of a long process of policy neglect and geopolitical decline. The death of Queen Elizabeth II has, amongst many other things, contributed to the sense that an era has passed, and that a new, more testing one is upon us.

Wrapped up in all this is the Brexit project, which has drained the UK economy of its vitality (investment, productivity and growth have stalled badly), exhausted the patience of Britain’s international partners and debased the political climate in the UK. That Brexit is not working is a clear message from financial markets.

Another longer-term message is that Britain’s outsized role in the international economy and world stage is now over.

Some years ago, the economist Barry Eichengren produced a paper that showed that through history, as empires have declined, so too has the role their currency has played in the international economy. This has led some to posit that the dollar should start to waken as we enter a multipolar world. If Britain does prove this theory correct, there should be a long lag to dollar weakness, if that is to happen. Bear in mind that at the time of the American Civil war, one pound bought ten dollars, and this fell to 4 at the time of the Suez crisis and, collapsed to 1 now.

A further source of comfort for Americans is that unlike the UK, the USA is not breaking up. In Britain, Brexit has detonated history such that Scottish independence is now likely in the next five to ten years, the reunification of Northern Ireland and the Republic is widely discussed, and there is even an upswing in Welsh independence sentiment.

Looking ahead, the chief issues now are in the short term whether economic and financial volatility will persist, and by association whether the Truss government survives its experiment with an economic model that appeared to work in 1980’s America, and then more challengingly, what becomes of the idea of Global Britain, and logically the ‘Little Britain’ that Liz Truss appears to be trying to create.

In the short term, there are two obstacles – the volatile financial market outlook and the rupture in the credibility of Britain as an investment destination, and a major economy (for comparison – British 10 year bond yields are 4% (helped lower by renewed buying by the Bank of England) whereas that of its neighbour Ireland trade at 2.7%).

In particular the reputation of the Tories as the stewards of the economy is in smithereens. The Tories face ongoing questions regarding their closeness to Russian money, and to the London hedge funds that shorted sterling.

There is now considerable speculation as to whether Kwarteng and Truss can continue – one wag compared her disastrous round of regional media interviews to that of King John in 1216, who whilst trying to fend off rebellions and invasions, caught dysentery in Norfolk, lost the crown jewels in The Wash and died in Nottinghamshire.

Kwarteng may be defenestrated after the coming Tory Party conference, but Liz Truss would be nearly impossible for the Tories to remove, because of the simple fact that there would be loud calls for a general election.

In the longer term, the UK needs at least two changes of tack. The first is an economic model akin to that of small, advanced economies like Sweden, Singapore and Switzerland that priorities access to good education and public goods, focuses on the drivers of productivity, values the rule of law, good institutions and the people who run them (the sacking of Sir Tom Scholar from the Treasury was significant in this regard). In my view, it is unlikely that Britain will adopt this approach, even though it has been shown to produce high quality long-term growth in a range of countries (The Lessons of Little States).

The second changes relates to the political system. The distasteful chaos of the Johnson premiership and the incompetence of the Truss one have resulted in a record lead in the polls for Labour. Should they come to power in a subsequent election, one choice that may confront them is electoral reform.

Introducing proportional representation in the place of the first past the post system would radically alter British politics – it would force collaboration, more coalitions and arguably foster a more policy focused debate. Importantly it would make it easier for parties to evolve. Brexit is largely the result of deep internal divisions within the Tory party that poisoned national politics because there was no suppleness in the party system.

Such a change might re-establish growth, and a sense of ‘order’ in Britain.

Have a great week ahead,

Mike

Last Monday evening I was driving along the contours of Cork harbour, not far from East Cork. The area has many claims to fame – for example, a local (Edward Bransfield) is credited with having discovered Antarctica in 1820. Less triumphantly, some local villages like Whitegate, Aghada and Farsid lost one third of their male populations during the Crimean War.

At the time, a great number of soldiers died from disease and the lack of basic medical procedures – whilst the French and British armies fought side by side against the Russians, casualties were far relatively far higher on the British side because of inferior medical equipment and practice – hence the acclaim with which Florence Nightingale’s techniques were greeted.

I thought of this recently when I read a post on the very different medical kits supplied to Ukrainian and Russian troops, respectively. Setting aside propaganda and donations from the West, the Ukrainian kit looked modern while that of the Russian soldiers could well have come from a museum or horror show. In that respect, the apparent wilting of the Russian army is not surprising.

More supporting detail on this comes from the 140 page long diaries of Pavel Filatyev, a career paratrooper in the Russian army who, driven to despair by the chaos within his regiment (in Kherson), wrote a long account of his experience in the Russian army. Armies are not pleasant places but his account of the systematic mistreatment of the Russian soldiers, their undernourishment, disorganization in battle and embarrassing under-equipment is telling, not just of the Russian army but of the Russian state. Needless to say, he is now in hiding beyond Russia.

In that context, the mobilization of largely experienced soldiers to start with, and the co opting of prisoners into the Russian army, opens up many risks – for both Ukraine and Russia. Additionally, the coming referenda on the accession to the Russian Federation of the Luhansk, Donetsk, Zaporizhzhia and Kherson regions is a sneaky, deadly moving of the geopolitical goalposts. Any attempt to liberate these areas of Ukraine would now, in the eyes of the Kremlin, an attack on Russia itself, and it has the right to respond as it sees fit.

From a military point of view, this elevates the risks around Ukraine, and in particular heightens the probability of a strategic mistake or tail event (i.e. such as the destruction of a NATO satellite or an attack on a Baltic state). Putin’s move also increases the risk of socio-political risk within Russia. As I am not a military expert but prefer to write on economic development and the rise and fall of states, I will focus on that.

The Filaytev diaries say much about Russia. It is a country that until recently had poor levels of human development, especially in healthcare and life expectancy (which has been rising from low levels). In this context, Vladimir Putin’s vision of Russia as a superpower is hollow – unless a nation can sustain improving levels of human development (through education, good healthcare, freedom of thought) it will not sustain the core drivers of growth, such as productivity. This a lesson for China, the UK and the US to follow. In China and the UK (productivity is falling) whereas in the USA life expectancy had dropped sharply (below that of China).

 In coming years, I am sure many will write about the surprisingly poor quality of the Russian army, and in the context of this note, it is simply another marker for poor quality development. This is perhaps one reason why when emerging market crises strike, they happen slowly, then very quickly. Incompetent institutions, poor rule of law and a prohibition on intelligent policy making can for some time be camouflaged by superficial growth, but all very quickly melt away in moments of stress (Russia has sadly seen this before).

The risk is that other institutions go the same way. As Putin announced the mobilization there were rumours that the highly regarded head of the Russian central bank, Elvira Nabiullina, had resigned (she had apparently tried to do the same in March). This has not been confirmed but raises the question as to the seaworthiness of the full range of Russian institutions in a stormy geopolitical climate. Increasingly, the pressure will be on Russia, and from multiple angles.

As a last word, I want to return to the Crimean War. It is not inconceivable that Corkmen from villages like Whitegate were shelled by Leo Tolstoy, at the time a young artillery officer. Tolstoy’s experience of war affected him greatly. In the context of Putin’s recent mobilization it is worth recalling some advice he gave to a young man ‘all just people must refuse to become soldiers’. Many young Russians are thinking the same today.

Have a great week ahead,

Mike

Whenever there is a crisis in Europe, and the EU has to evolve, the rejoinder goes up that Jean Monnet, one of its founding fathers said ‘Europe needs a crisis to move forward’, and Europe then muddles through. It is, however, worth noting a different point of view. Monnet’s father, a merchant from Cognac is on record as saying, “Every new idea is a bad idea.”

Monnet senior’s views would not find as much favour in Brussels as before, largely because the world is changing rapidly, and Europe’s leaders are waking up to the new to realities of the end of the globalized world system and the arrival of a multipolar world, thanks in large part to the actions of three ‘strong’ men- Donald Trump, Vladimir Putin and Xi Jinping.

Trump has sowed doubt in European minds that the US may be in political decline and that it could be a less reliable partner, Xi has awoken them to the realization that trade with China involves a double-edged compromise, whilst Putin reminds them that Europe is again challenged by uncompromising evil, and needs to combat this.

I have written many times about the gathering momentum towards the notion of Europe as a geopolitical power. What is new is the speed at which this is happening. Europe took some five years to bring order to its fiscal and economic policy, and this is still half-formed. In contrast, European foreign, security, energy and political policies have been transformed in six months. The import of this transformation is not yet appreciated in Beijing, Washington, and London.

These capitals may feel that they are better off dealing with individual governments in Europe than the EU itself. Brexit, where the EU Commissioner was the trusted negotiator for the 27 countries, showed that this is increasingly less the case, and the response to the energy crisis also shows that EU countries are better together.

In the next few years, the idea of Europe as a power is likely to take hold. Practically what this means is that it will seek a more distinctive and powerful voice (at EU level) on foreign policy and that this will be informed by the EU’s social democratic values.

Correspondingly, Europe will have a more coherent, broader defense and security policy that will spill over to the idea of industrial sovereignty – effectively Europe will be ‘self-sufficient’ or have autonomy in key defense, industrial and technological areas. To a certain degree, Europe is simply catching up with the US and China here. From an investment point of view, we should expect to see deep secular trends in green energy, environmental technologies, defense and cyber security, and consolidation across fintech and healthtech in Europe.

Sceptics may feel that they have seen it all before.

There are clear hurdles. The first is the game-theoretic aspect of shaping ‘common’ policies, and then ensuring that the implementation of these does not fall foul of political developments in individual member states (e.g. Italy). Additionally, with Germany still in a state of geopolitical confusion, much depends on France getting on with the likes of Lithuania and Poland.

The second is the implementation – for instance fostering innovation in new technologies and building a tangible sense of what ‘European values’ mean to people, are best done bottom up (a very good example is the recent launch of Democracy Next http://www.demnext.org), than top-down as is the way in Brussels.

In that respect, there are a few proving points ahead. One is whether the EC will appoint a high profile foreign affairs commissioner and give him/her additional power and institutional capacity over policy, so that they do not play second fiddle to the French and German foreign ministers. Another test relates to the nature of defense spending and, apart from all the tanks and helicopters that individual armies like Germany need, whether more is spent on ‘common’ defense infrastructure such as heavy lifting aircraft. Related to this, a further test is whether the EU is prepared to take aggressive, as opposed to defensive, action against another state. An EU coordinated cyber-attack on one of a number of ‘Internet Research Agencies’ would be a significant development.

One ‘test’ that is looming is in the realm of democracy. Europe’s leaders have talked a lot about its democratic values, and the invasion of Ukraine has brought this into stark focus. What is new is that this debate was the focus of Ursula von der Leyen’s annual address last Wednesday where she criticized ‘Trojan horses that attack our democracy from within’ and notably stated that ‘many of us have taken democracy for granted for too long. Especially those, like me, who have never experienced what it means to live under the fist of an authoritarian regime’.

In that context, Hungary is the test case. It is likely to be deprived of billions in EU funding (up to Eur 40bn), and there is growing talk of finding legal means to exclude it from the European Council, and potentially the EU. The current mood in Brussels is, given Viktor Orban’s closeness to Russia, to push Hungary very hard. 

In a very different age (2004) when the euro traded well above the dollar (1.30 in late 2004, as opposed to .999 today), Jean-Claude Trichet, the then chief of the European Central Bank declared that ‘brutal’ moves in the euro were unwelcome. His use of the word ‘brutal’ – it has a far stronger meaning in English than in French – and he, as the son of a literature professor might have known better – led to even more jumpiness in markets.

A couple of years later (July 2008), Trichet made another, school-boy error – raising interest rates in an apparent response to a spike in the price of oil. Coming one month before the biggest financial crisis in recent history, it was a clumsy move given, in any case, the tenuous relationship between the price of oil and euro-zone rates. It was also a mistake that set the scene for the rest of Trichet’s stewardship of the euro-zone during its crisis period.

It is a case study that is worth examining again in the light of last week’s ECB meeting where rates were raised by 0.75% and where the ECB expects inflation to persist above 5% through 2023, having confidently forecast it closer to 2% at the start of this year. The ECB cannot expect that the blunt instrument of monetary policy will have any effect on gas and electricity prices – both of which are driven by market micro-structures and the complexities of geopolitics.

At the same time, the ECB like the Fed, is privately aware of the embarrassing inaccuracy of its forecasts (see our note of November 2021 ‘Pantomime Monetary Policy’) and the risk that a decade of easy monetary policy has let the inflation genie loose (see property and service price inflation for instance). For that reason, I suspect that the ECB, like other central banks, will continue to lean against inflation, with the high risk that we see a recession in Europe by year end. Markets are currently pricing in 2% in interest rate hikes up to next March, even as European manufacturing activity and consumer sentiment collapse, and financial conditions tighten. Another mistake may be in the offing.

There is however an important change afoot.

In 2011, in the thick of the euro-zone financial crisis when Mario Draghi became the ECB President, he and the institution were effectively the glue holding the Union together. Many of the deep political and policy relationships at the EU were forged during the euro-zone crisis and helped to build the sense of solidarity that carried through to negotiations with Britain on Brexit, and the urgency that is now manifest at the Commission level.

To that end the EU is now evolving at a rate and a magnitude that is still largely unappreciated. It has Vladimir Putin and to a lesser extent, Donald Trump to thank for imparting a sense of urgency to the EU’s strategic deliberations across foreign, energy and security policy in particular.

In the last week it has begun to show that it can take aim at electricity(gas) prices – something that individual states could not do on their own without surrendering their moral capital (with the exception of Hungary). The EU itself will not be able to kill off broad inflation – that is the job of the ECB – but it can certainly curb the pernicious effects of the weaponization of energy by Russia, and in so doing avoid misery and the risk of social unrest. It may also need a coordinated framework for the institutional support of utilities and energy producers, many of whom are as financially stressed as the sub-prime sector was in 2009.

My own sense is that the ‘winter energy’ chaos that some speak of will not materialize in as extreme a manner as feared (nuclear, hydro powered electricity are rebounding in capacity), and that the ultimate consequence of the spike in gas prices will be to destroy the largest source of demand for Russian energy.

In that context, the EU will emerge stronger and better prepared from this crisis, in the same way as it has done in the aftermath of Brexit. As it evolves, the ECB should also examine how it can improve and adapt to a changing world.

Here I want to reiterate a few suggestions I have made in recent years, starting with diversity. Central banking is not a diverse place, made up mostly of middle-aged males. What is more telling is that all of these males, and the growing number of females that join them, are formed in the same way and look at the world in a similar fashion.

Most of the members of the policy committees of the Fed and ECB have spent their careers in central banking circles, with the odd jaunt in and out of academia. As a result there is little diversity of experience at the top of the main central banks, and central bankers are not well socialized to the implications of their policies on the outside world. In the future, in addition to greater gender diversity, it may well be useful for central banks to appoint decision makers with a greater variety of experience across industry and other related walks of life.

A really important sub-element here is to appoint policy makers with a sense of the consequences of their actions, and an ability to alter their view when it is wrong. Forecasting as they say is hard, especially when it is about the future and to a large extent the role of the central banker is about mapping and creating a vision of the economic future.

Where this vision jars with reality, policy makers should ideally be conditioned to rethink their positions or be equipped with simple devices like the Bank of England Governor’s ‘letter to the Chancellor’ (the Governor must write an explanatory letter to the Chancellor if inflation deviates from target by over 1%).

A further innovation, at least for the ECB is to give local central banks more autonomy over their economies. This will take a degree of experimentation but the idea is that depending on the structure of an individual economy (compare Ireland and Greece to Texas and Kansas), specific macro-prudential policy levers could be developed to cool or speed up local economies in the context of overall monetary policy.

My pessimistic conclusion is that many of these and other suggestions will have to wait until the next recession to get a hearing, when central banks start to prosecute QE4 to undo their most recent mistake.

One of the (many) remarkable American political events of recent months has been the defeat of Liz Cheney in the primary race to regain her Republican seat in Congress. Cheney is republican royalty, at least as far as the Bush/Reagan Republicans are concerned. Her father (see Barton Gellman’s book ‘Angler’ as a reference point) was integral to many Republican administrations, and devious enough that when George W Bush asked him to search for a vice-presidential candidate, Cheney could find no-one better than himself.

In Congress, Liz Cheney’s voting record has been sufficiently red-blooded that there is no doubting her convictions, save that she is a rare example of a Republican resisting Trump sycophantism. She is experienced and learned enough to realise the threat that he represents to American democracy and is making this her stand. In so doing, and in promising to derail a 2024 Trump presidential campaign, Cheney may become the catalyst to split the Republican Party, which like the Tory Party in the UK, is a cauldron of venom and confusion.

If the Republicans were to split, the centre group of American politics might open up, whilst the Trump Republicans could amuse themselves on the fringes of the political establishment and social media. To that end, the coming mid-term elections – which have already been heavily influenced by the Supreme Court judgement on nation-wide access to abortion – will be telling. Interestingly, they may not be the most significant political event this autumn.

Against an international backdrop where democracies are fighting within themselves in an often-existential way, and where in the context of the invasion of Ukraine and tensions around Taiwan, the democratic and autocratic worlds are facing off in an increasingly hostile way, the key event will be the meeting of the Chinese Communist Party in late October, early November.

This event is key because it will likely anoint a third term in government for Xi Jinping, and usher in some important personal changes – notably a new prime minister for China and the retirement of Wang Qishan.

It is an underestimated watershed event in the sense that it marks a phase change in China’s rise from a one-party to a one -man state. If the example of America proves that democracy begets prosperity, China is the powerful counterexample that proves that a controlled, state directed economy can also thrive. The transition to ‘Xi for life’ could upset this, and in this context, there are several considerations to bear in mind (not least with markets looking complacent).

The first short-term one rests on Xi’s need for a show of force in the lead up to the CCP meeting. While we risk assuming that Chinese politicians have a ‘wag the dog’ (see the 1990’s book ‘American Hero’ by Larry Beinhart and film of this title) tendency in the same fashion as their US counterparts, a continuation of strongarm tactics around Taiwan (a blockade or even the seizure of a small island) is a possibility.

A more pernicious and damaging trend within China are the side-effects that Xi’s instincts for control are having – at least three have come to my attention. The first is the debilitating effect on public morale and the economy of the various COVID lockdowns, and the discrete rumblings that these are creating within the broad church that is the Communist Party. The second is the effective split between the Party and the business community that has developed because of Xi’s anti-corruption drives and his promises of a less unequal wealth distribution (‘common prosperity’) and the third relates to the hushing of open, intellectual endeavour and vibrancy of discussion around social and political affairs. By extension, this makes Chinese politics extremely hard to decipher.

In this respect, the great danger for China is that it has someone at the helm who smothers innovation at a time when China needs it most. With the demographic cycle shifting downwards, growth slowing and the property market looking precarious, the risk for Xi is that he fails to deliver on the ‘China Dream’ concept he started expounding in late 2012/early 2013. Bear in mind the sobering fact that youth unemployment in China is now 20%.

In the rise of a country from emerging to developed status, the key variable to watch is continuous improvements in productivity, and in China this is faltering. In that respect the great surprise would be that Xi is a lame duck president by 2027, when Liz Cheney might be starting her presidential campaign for 2028.

I am taking a break for two weeks and this column will resume on September 10^th. Have a great week ahead, Mike