I have started to write a new book – this time on democracy and politics in France (with Pierre-Charles Pradier), but with the usual impeccable timing I think I may have chosen the wrong subject at the wrong time. Against a backdrop where the Tory Party is about to choose Liz Truss as its leader, and Italy has proven too much for the admirable Mario Draghi, France is a bastion of political peace and stability!

At the time of writing, it looks like Mario Draghi’s time in Italian politics is over (he may yet become president) and given the way he led the country during the COVID crisis, oversaw a rebound in its economy and restored the authority of Italy as a foreign policy voice, this is a loss for Italy. Moreover, that someone of his credibility and achievement can be spat out by a political system is deeply disheartening.

From a political labour market point of view Draghi is the ‘opposite’ experiment to the likes of Boris Johnson, Liz Truss, Donald Trump and Jair Bolsonaro and a growing list of other opportunists in the sense that he entered politics from a position of strength and accomplishment and was likely more motivated by public service than self-interest. He may have lacked the popular touch, but at a time when most people are put off public life by its viciousness, the potential exit of Draghi is a pity, and a costly mistake for Italy.

The government he led collapsed for several reasons. One is that the populist 5 Star party has found its support shrink given its role in government. The decision of Luigi di Maio to leave 5 Star and pursue a more serious political career shows that for some at least there is a viable transition from populism to power.

Similarly, to 5 Star, the two right wing parties in the Draghi government, the Northern League (Lega) and Forza Italia (recall Berlusconi) have lost their lustre with voters because of their participation in government and have been surpassed on the right by Giorgia Meloni’s Fratelli d’Italia party. She is interesting, for mostly the wrong reasons.

To start with, there are at least two similarities with France. The first is that in terms of parties, Italy’s system is fragmented – comprising a centre (France’s centre is larger and more robust) surrounded by parties of the ‘far’ right and left, that style themselves as being against the ‘system’.

In recent years ‘anti-system’ parties in Italy have positioned themselves against Europe and the euro, though the new development is that whilst being ‘anti-Brussels’ Meloni’s rhetoric is more ‘anti-globalist’ (Draghi is seen as a high priest of this movement, whose capitol is Davos). Similarly French politics has switched from a left-right wing axis toward one where disenchanted locals pit themselves against the elite globalists (as they portray Macron).

Meloni is also interesting politically in that she cultivates relationships with far-right politicians in other countries – Le Pen in France (whose niece is also building an international network of neo-facists), Orban in Hungary and some Republicans in the US. Whilst this is not a novel development, there are few such networks, and in this case, it is a menacing one.

This made all the more worrying by the links that Italian political parties have to Russia, notably Meloni, Matteo Salvini of the Northern League and of course Berlusconi’s personal ties to Vladimir Putin. Given what is happening to Ukraine, these ties have, in the context of elections and a new government, the potential to undercut support for Ukraine from Italy, and to permit Moscow an avenue through which to destabilise Europe’s response.

There will now be an election on September 25, and polls suggest that the next government (a technocrat led caretaker government till next spring is also possible) will be formed of (far) right parties, possibly led by Meloni, orchestrated by Berlusconi. It is still possible that Italians revolt against the populist parties (one thousand mayors have signed a petition in support of Draghi)

Broadly speaking the policy agenda of the right lacks originality, and squanders whatever fiscal space Italy possesses. The ECB’s new ‘anti-fragmentation’ policy toolbox complicates things even further because the conditionality it demands is only found in economically upright, cooperative euro-zone countries. To that end, Italy may become a source of political tension with Brussels, and volatility in bond markets. The one important carrot Brussels has in the EU Next Generation Fund, where further disbursements are contingent on ‘good behavior’.

The greater challenge for Italy’s political class, having jettisoned Draghi, is to come up with either a leader or a set of policies that bring growth to Italy, and give it more of the prestige that Draghi brought. Like most populists, they will likely do the opposite. 

Have a great week ahead,

Mike

The Swiss government’s Spiez Laboratory, one of whose specialisations is the study of deadly toxins and infectious diseases, is located right in the heart of Switzerland, incidentally not too far away from the Reichenbach Falls, where Sherlock Holmes vanquished Professor Moriarty (more about him later) in ‘The Final Problem’.

Nine months ago, scientists at the Lab performed an experiment where they deployed their artificial intelligence driven drug discovery platform called MegaSyn to investigate how it might perform if it were untethered from its usual parameters. Like many AI platforms MegaSyn relies on a large database (in this case public databases of molecular structures and related bioactivity data) which it ordinarily uses to learn how to fasten together new molecular combinations to accelerate drug discovery. The rationale is that MegaSyn can avoid toxicity in molecules, and thus sift ‘good’ ones.

In the Spiez experiment MegaSyn was left unconstrained by the need to produce good outcomes, and having run overnight, 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.

Another recent example is the reported conversation between Blake Lemoine, a Google employee, and a computer program called LaMDA which Lemoine reported publicly as being sentient. Whether this is true or not, we are at a stage where AI is advancing towards AGI or Artificial General Intelligence, where computers can learn and begin to think like humans, not unlike Alan Turing’s famous ‘test’. Indeed, an AI program called GPT-3 can write half decent fiction.

Scarily still, there is already plenty of evidence to suggest that AI is playing a military role. In Ukraine, drones have been programmed to recognise Russian military equipment and to attack it. Larger nations can harness AI to weapon systems to make them seek and destroy their enemy and having seen the effect that drone technology has had in the Nagorno-Karabakh war, we may not be far from an AI driven war.

This example and the broader emerging debate around AI give us a sense that in the new world order that is being formed, there are multiple, complex axes. For example, much is made of the growing strategic rivalry between the USA and China, and part of this rivalry will surely focus on AI – in terms of computing power and access to large public and private data sets (Europe is ahead of both the US in seeking to rein in how data is used in AI). Within these large regions, another line of tension will run between humans and the impact that AI has on their lives (such as on minorities).

It is, however, not all negative. In a widely reported experiment last week, a project called Democratic AI allocated the outcomes from an investment game, in a way that was more egalitarian than the outcomes chosen by purely human actors. It suggests that whilst the research benefits (and dangers) of AI in settings like biotechnology are more tangible, there are also very clear policy outcomes (for democracy and public policy) as well.

At this stage, it is not controversial to say that most governments are far behind where they need to be in understanding and better marshalling the effects of AI on our lives (from insurance contracts to airline prices to the interaction between social media and politics). While I can’t claim to have a clear insight myself, I can recommend a few decent resources – the State of AI report, Kai-Fu Lee and Quifan Chen’s book ‘AI 2041’ not to mention the entertaining ‘the Love Makers’ by Aifric Campbell.

Now back to Moriarty, another man with dark dreams of being ‘world king’. Rumour has it that one of the people that inspired Arthur Conan Doyle’s characterisation of Moriarty was George Boole, Professor of Maths at University College Cork from 1849. Boole, one of the great mathematicians, created Boolean algebra which laid the foundations for computer language and is this the structure around which scientists use machines to mimic and ‘improve’ on human behaviour.

I spent years in the basement of UCC’s Boole Library, slaving away on AI – though I didn’t know it at the time. The trouble is that back then it was called regression analysis, data sets were very, very limited and computing power was, from today’s perspective, prehistoric (see my account).

If I had known that the regression caterpillar would turn into an AI butterfly I might have stuck with it. My lesson is that computing power, and in certain cases data sets, will improve further, and as they do, they will push the boundaries of law, moral philosophy and strategic competition between the large regions.

Time to bring back Sherlock!

Have a great week ahead,

Mike

In the film Mutiny on the Bounty, Captain Bligh declares to his militant crew that ‘beatings will continue till morale improves’. This tactic doesn’t end well for Bligh, though he eventually makes it to safety. Yet, the notion of ‘beating till the morale improves’ is perhaps better applied to financial markets. As a very simple rule, in the case of underlying imbalances or economic stress, they (market prices) will often extend to levels that cause pain.

The past number of weeks have been an excellent case in point. Extreme moves in commodity prices for instance have caused hardship, political turmoil, and increasingly, unrest (Sri Lanka for instance). This introduces several levels of socio-political complexity into the debate on markets. The value of free moving prices (as opposed to those under the spell of quantitative easing) is that they send signals about the health of the world economy and its moving parts. Policy makers should pay attention to these and map their implications (will we have fuel shortages and power cuts this winter?).

There is also a countervailing argument that extreme price moves that harm people’s livelihoods should be curbed. To an extent that is hard to do on a consistent basis and is ultimately the role of central banks at a broad level – most of whom have failed their mandates. We should expect that for the rest of this year, many nervous governments will deplete their fiscal capital.

One market signal worth paying attention to is the dollar, whose recent strength has manifest itself as yen weakness, and is now driving the euro down towards parity with the dollar. A range of emerging market currencies – Chilean peso for instance – have also sold off. At one level these moves can be interpreted as individual regional stresses (German trade weakness notably) but a more comprehensive view is that dollar strength is signaling demand by investors for safe(r) assets and money. Should dollar strength persist, it should be a cause for concern, as a signal of what is occurring in portfolios, and for the spillover effects that could produce a mini ‘dollar’ crisis (see this ‘our dollar, your problem’ note from David Skilling).

With the half year point now here and having been through multiple sell-offs (commodities being the latest), the pain trade is still likely with us, but could be expressed in two very distinct ‘pain’ channels, both of which depend on the reaction function of central bankers and will have marked socio-economic effects in years ahead.

It is possible that, mindful of the drop in commodity prices and especially the more politically sensitive aspects of these (gasoline prices) and the implications of this for headline inflation, central bankers begin to soften their message on ‘killing off’ inflation. In particular, it is not yet clear that central bankers have the levels of monetary sadism required to stomach the collateral economic and political damage associated with thoroughly suppressing inflation. In that respect they might adopt a ‘living with higher prices, avoiding recession’ stance.

While to a certain extent this is priced into interest rate markets (they expect the Fed to cut rates through 2023 and mortgage rates are dropping from a high level) an ‘inflation permissive’ message from central bankers would set in train a new market and economic regime.

Bond markets would weaken, commodities rally as an inflation hedge, as would the stocks of companies with pricing power. It may also be that the equity value of companies with large debt levels would rise, given the real effect of high inflation/steady rates on debt. Economically however, the prospect of a higher trend level of inflation could lead to upward pressure on wages, at least for those who have bargaining power, and in broad terms would lead to a relative transfer of wealth from asset poor lower income workers to wealthier, higher earners.

Another monetary piste down which the Federal Reserve and other central banks can travel is to persist in the fight to flatten inflation (for the moment the most likely scenario). This bid to reinforce their credibility would occur in the face of weakening economic activity (the Fed has unusually been raising interest rates in the face of record lows in consumer confidence), where they would continue to ratchet rates upwards until inflation overshot to the downside (early next year).

The effect of this in wealth terms would be more vicious deflation in asset values, most notably property prices in the developed world (Australia, Canada, the US are vulnerable). The economic effect would entail a sharp recession, and a large negative wealth effect on the wealthier classes. Politically, a number of governments would, simply by association bear the downside (though Biden’s approval ratings are already strongly negatively correlated with inflation) and we may well likely see a sharp deterioration in relations between politicians and central bankers.

Many central bankers would understandably wish that inflation would melt away, and to a large extent supply chain blockages and commodity price rises are ebbing. There is still the risk that service price inflation and rents push higher, and that these rises prove sticky and hard to reverse. Resolving these pressures will be complex and will involve a coordinated effort between governments and central banks to best distribute the economic ‘pain’, and at a time of great change, maintain social cohesion (mindful of the political consequences of the 2009 global financial crisis).

Have a great week ahead,

Mike

I usually go through a rhythm of reading one or two serious books, followed by a few works of fiction and with summer on the way I wanted to highlight a few of both. In that regard I have just finished Laurence Durrell’s ‘White Eagles in Serbia’, an old-fashioned espionage thriller where the hero Colonel Methuen is dropped behind enemy lines in post war Serbia (he speaks excellent Serbo-Croat) and becomes embroiled in a violent plot to overthrow Tito.

The book is a warm-up to reading Durrell’s ‘The Alexandria Quartet’, a work that nearly won him the Nobel Prize. Durrell was part of an interesting Anglo-Irish family, who largely considered themselves Indian – his brother Gerald, the naturalist and writer, touches on this in ‘My Family and Other Animals’.

Though I am not an expert on these matters, I found ‘White Eagles’ a more realistic account of espionage than much of what we see in the media today (Mick Herron’s ‘Slow Horses’ is good), and overall it is a tale of derring-do that is more in keeping with the work of the founding fathers of the genre – Eric Ambler, John Buchan, Erskine Childers and Ted Allebury for example.

It also made opportune reading given what seems to be an epidemic of espionage – with reports of the Chinese hacking group APT40 using graduates to infiltrate Western corporates and notably the admission by the head of Switzerland’s intelligence that Russian espionage is rife in that country (notably in Geneva – for which readers should consult Somerset Maugham’s ‘Ashenden’ as background material).

These and other trends – such as the outbreak of a heavy cyber battle last week (against Lithuania and Norway for instance) and the increasingly public ‘clandestine’ war between Israel and Iran (they have just sacked their spy chief) point to a world that is ever more contested and complex.

One of the new trends in the space is cyber espionage – both in the sense of stealing state and industrial/corporate secrets, influencing actors (such as the manipulation of the 2016 US Presidential election) and outright acts of hostility such as the hacking of public databases and utilities (i.e. healthcare systems). Here, if readers are looking for some serious literature I can recommend two excellent books – Nicole Perlroth’s ‘This is how they tell me the world ends’ and ‘Secret World’ by Christopher Andrew.

I am personally more intrigued by the difference between a spy and a strategist. A spy’s work could well be described as the pursuit of information about someone who is acting with a specific intent, as well as a sense of their reaction function. There are plenty of examples – from Christine Joncourt (‘La Putain de la Republique’) to Richard Sorge (see Owen Matthews’ ‘An Impeccable Spy’).

In contrast a strategist may try to plot trends and the opportunities, spillovers and damage they may cause. The US National Intelligence department is good in this regard, becoming the first major intelligence agency to publish detailed warnings on the side effects of climate damage.

Spies and strategists might work together, but history is full of examples (LC Moyzisch’s ‘Operation Cicero’) where intelligence fails to make it through the strategic process or is simply ignored for political reasons (might the early warnings on the invasion of Ukraine be an example).

In the spirit of the Durrells and Flemings of the world, what issues might be of interest in terms of digging into unknown knowns and unknown unknowns. Here are a few ideas, most of which are Asia focused (we might see an uptick in Asia focused thrillers).  

On the diplomatic front, an interesting recent development was the visit of Indonesian president Joko Widodo to Ukraine, and then Moscow. It was a rare visit to Ukraine by an Asian leader and potentially marks the emergence or at least aspiration of Indonesia (population 273 million) as an emerging world diplomatic player. What has intrigued me so far is that there has been little coordination by the populous emerging (largely Muslim) nations (Nigeria, Indonesia, Pakistan) in the face of high energy and food prices, and that potentially Widodo could play a unifying role here.

Then, still in Asia, but on a more deadly footing, if the Western commentariat is to be believed, China is preparing an assault on Taiwan, and looking to learn from Russia’s military errors in this regard. Other countries are reacting, and I suspect that there will be much intrigue around Taiwan’s ability to acquire sufficiently powerful ballistic missiles that could strike the coastal cities of China, and relatedly how long might it take Japan to produce nuclear missiles (my sources say they could very ambitiously do it in five months!).

So, whilst the espionage literature of the 20^th century has tended to be focused on Geneva, Berlin and London in the 21^st century we may find ourselves reading about ‘behind the lines’ exploits in Jakarta and Tanegashima.

Have a great week ahead,

Mike

One of the striking images of recent current affairs is the leaders of France, Germany and Italy in a train compartment on their way to Kiev. Trains have played an important part in the history of European wars. For instance, armistices for the first and second world wars were signed in carriages and the professionalisation of the German army officer class in the lead up to the first world war was driven by the need to rationalise complicated train timetables (it’s a long story).

Emmanuel Macron’s trip to Kiev offered him a much-needed chance to clarify his stance on the war, though his return to Paris was less happy as he subsequently lost his absolute majority in parliament. My sense is that the rise of the far left and right in France is less damaging in the near term for Macron – he will likely gain support from the right ‘Les Republicans’, to the long-term benefit of Edouard Philippe perhaps. What is more interesting in my view, is the way the war in Ukraine, democracy generally and specifically in France, are all linked.

As a general point, democracy is in difficulty. According to the Economist Intelligence Unit, only 13% of the world’s countries are full democracies. What is more worrying is the erosion of democracy in core democratic countries – such as the lack of convincing opposition to Boris Johnson’s bulldozing of British institutions and the rule of law, and the carefree way in which many Americans greeted the findings of the January 6^th inquiry.

French democracy is in a much better place than its two Atlantic neighbours –together with Ireland all four countries are important in that they make up the crucible of modern liberal democracy – but it is still troubled. In this context, France is an interesting case study for several reasons.

The first is that politically, largely thanks to the policy energy of Macron, it is the most important country in Europe. On the train ride to Ukraine Mario Draghi referred to Macron as the ‘president of Europe’. So, where France goes, Europe goes too.

Second, the French political system is fast evolving – the two dominant parties of the last forty years have been smashed by Macron’s ‘revolution from within the system’ and now he is surrounded on either side by two system outsiders (they have been around for so long they are really insiders), who champion the discontented and who to different degrees, are friends of Russia. As such, the French system has moved from left to right, to inside v outsider, or more aptly ‘upstairs v downstairs’, though Le Pen and Melanchon are also possibly both richer than Macron, the ‘president of the rich’!

France is also interesting in that while the outsized role of the state has managed to soften the blows of successive crises – eurozone, COVID and now inflation – it has also created a broad view that the state is the solution to all ills. At this juncture, this cannot continue because with government spending at or above 55% of GDP, France has no fiscal space left.

With regard to French democracy, this may produce some forced, interesting innovations – such as a greater consideration of citizen assemblies and more autonomy for regions. Expect to hear more about these and other related ‘clever’ ideas from me on democracy, though my great worry is that they fall on deaf ears, and that something disturbing needs to happen in order that people realise the challenge ahead.

So, consider this. What is Russian wins the war in Ukraine. In this respect, winning the war does not require Russia takes Kiev, but rather it takes and obliterates the southern and eastern perimeter of Ukraine, sues for peace and then retreats on the basis that sanctions are lifted. Other events follow, Navalny mysteriously dies, Russia provides grain to friendly countries and the Russian military and business classes are purged of anyone who is not ‘hard line’.

Pessimistically some countries, from the UAE, Turkey, India and Germany (Scholz’ foreign policy advisor betrayed as much) seek to build relations with Russia, which remains a pivotal commodity power. The example, to other countries (recall 54% of the world’s population live in hybrid democracies or authoritarian regimes), is that the West and its value system is weakened, ‘strong manism’ is emboldened and the idea of ‘managed democracy’ becomes the prevalent form of government across the world – leading to, amongst other things, brain drains, capital flight and diminished productivity. Hong Kong is a great example.

That is a depressing scenario but it underlines the point that whilst the two large English speaking democracies undergo their own internal political turmoil and institutional decay (Roe v. Wade the latest example), that Europe is the focus of an existential struggle around democratic values. In this struggle, Ukraine, Serbia, Moldova, Hungary, Georgia and Belarus are all frontier states – and will all have to choose sides, and arguably should be made to choose sides.

I am not sure European leaders fully grasp this. When they do there is a significant project ahead – more carefully listening to and incorporating the views of the Baltic states and even Poland (France needs to listen hard), while treating increasingly non-democracies like Hungary even more harshly. Countries like France need to lead by example, changing political funding laws and media ownership. At a European level, there is a need to listen to people and build their needs into the practical workings of European liberal democracy, rather than framing theoretical posturing on enlightenment.

Have a great week ahead,

Mike

Regular readers may be a little bored with me repeating my ‘Interregnum’ thesis every week, but as a framework it appears to work on a growing basis. The thesis is that in this post-globalization phase in world affairs, the boons of globalization are being quickly reversed – low inflation, low rates and geopolitical peace have given way to record high inflation, lightning rate increases and a brutal war in Europe. Another facet is the vandalisation of the pillars and sacred cows of the old globalized world order – from trade agreements to diplomatic ties and niceties.

In the past week, another event has come along to confirm this framework – the attempt by Boris Johnson’s government to jettison the Northern Irish Protocol, an action that would effectively undercut the Good Friday Agreement.

Many of you who do not live in or near Ireland will be forgiven for not understanding the complexity of Irish history, and the particular intricacies of Northern Irish politics and how this has dovetailed into Brexit (for example the ‘backstop’ bamboozled most people including Tory politicians). I especially wish that more members of the Johnson government would spend more time trying to grasp the above and the implications of their careless approach to policy making.

The Good Friday Agreement (1998) which was painstakingly negotiated is one of the diplomatic triumphs of the globalized age, and its main actors received the Nobel Prize. Together with the steady building of a close relationship between Germany and France in recent decades, it is one of Europe’s outstanding diplomatic events, and one that is shared between Britain, Ireland and America.

Now, the Johnson government wants to scrap key elements of the Northern Irish Protocol, which sets out how the flow of goods into Northern Ireland and was designed to recognize the specific situation of Northern Ireland. As it stands, the Protocol in effect keeps it within the EU in that regard, with a ‘border’ across the Irish Sea acting to vet the flow of goods into Northern Ireland. The Protocol was part of the Brexit Agreement signed off by the Tory government, though now unpopular with Unionist leaders who felt that the Protocol was the beginning of a severing of ties between Northern Ireland and Britain.

The majority of members of the Northern Ireland Assembly do not want the Protocol removed or reordered (note for background over 60% of people in Northern Ireland voted against Brexit and those that voted for it now seem most perturbed by its side-effects), neither do the EU, US and Irish governments. Introducing a Bill to scrap the Protocol risks a breach of international law, gravely undermines the reputation of the UK as a reliable international partner and would potentially breach the Good Friday Agreement in that it would displace the role of the European Court of Human Rights in Northern Ireland (formally written into the GFA).

Impracticalities in the Protocol arrangement can and should be negotiated in good faith between the British and Irish governments (who now feel that Anglo-Irish relations are the worst in forty years) and the EU. Yet, the way in which the Johnson government has handled this effectively squanders the possibility of ‘good faith’ negotiations.

What is altogether more puzzling and alarming is why the Johnson government has deployed a strategy that will gain it relatively little (some kudos with Eurosceptics and Unionists) at such a great cost.

The leading explanation is that this is a mixture of a high risk survival strategy by Johnson, coupled with the usual disregard for the consequences of his actions (notably the prime minister’s ethics advisor has just resigned). As with Brexit the calculations of the internal dynamics of the Tory Party trump the welfare of many and the reputation of the UK. Another example is the cruel policy of sending asylum seekers to Rwanda.

A more troubling explanation is institutional decline. In common with other headline policy debates (such as that over international monetary policy and inflation) the latest move is a mistake that aims to cover a previous mistake(s) (Brexit and the way in which London negotiated it).

There is now growing evidence (most recently from economists at the LSE) that Brexit is hampering the UK economy (though Northern Ireland’s economy is thriving ‘within the EU’). This macro context, and the prosecution of policies such as the change to the Protocol, will relegate the UK well below the super powers of the multipolar world. A risk is that the large actors lose patience with it and disregard it, and that in time the same happens to sterling. A trade war with the EU would set this in motion and damage the City.

At a time when the rise and fall of nations is being accelerated by the end of globalization, Boris Johnson is gambling with his nation’s relevance. Around him, the UK is changing. Scotland may soon become independent. Northern Ireland itself is changing slowly but perceptibly (the strong vote for the progressive Alliance Party in the Assembly elections is an example), Brussels has switched its attention to other weighty matters, and the economic climate has darkened.

Following the half-hearted attempt to remove him recently, I suspect Boris’ days may be limited (September) once a credible challenger comes along from the Tory centre or the Labour party. If he does go, there will still remain the task of resetting British democracy (it is not alone in this respect), restoring standards in government and renewing the attractiveness of public service across the civil service in particular.

As a last promising word, a sign that parts of Britain have not lost hope nor contact with Europe, a French brigadier general, Jean Laurentin, took command of the British Army’s 1^st Division!

Have a great week ahead,

Mike  

Six months ago, I tried my hand at imagining how 2022 might transpire in markets, economies and politics. Whilst I am usually highly sceptical about forecasting (‘its role is to make astrology respectable’), my prognostics were sufficiently telling that I will now claim a certain wisdom.

The secret is to make ambiguous statements about a wide range of events, and some of them will stick. In this respect I prefigured Boris Johnson’s difficulties, the war in Ukraine (Bosnia was also a potential hotspot), Macron’s win and China closing down (https://thelevelling.blog/2021/12/18/2022-whats-next/).

Looking ahead, it is stating the obvious that the shape of the next six months will be determined by the damage caused by the war in Ukraine and the policy response to high inflation though what is more interesting and challenging is to frame their secondary effects.

Perhaps the easiest factor to parse is the change in monetary policy from the Fed and other central banks, and the effect that this has had on technology and other growth stocks – at the depths of the sell-off in May, market stress indicators were recording levels only seen in major economic and financial crises (i.e. 2001, 2008, 2020).

In crude terms, the sharp change in monetary policy is a ‘policy mistake chasing a policy mistake’. Nakedly, overly-generous monetary and fiscal policy in 2020 and 2021 will now be corrected by a monetary policy overreach.

As such, my first ‘prediction’ to use that horrible term, for the rest of 2022 is that the market and economic dynamic will shift from financial market volatility to the contagious effects of this into credit markets. This is dangerous, and operating and financial leverage will rebound badly on companies exposed to them. For context, a worrying data release last week was that US credit card debt hit an all-time high.

In that respect I think credit spreads for risky companies and countries will rise and default rates will spike as we approach September. This may create enough stress on corporations and consumers that the rate hiking cycle comes to an end, though at a huge cost in terms of jobs and wealth.

Another tell tale sign is whether expectations of weaker demand bring the oil price down towards USD 75 per barrel, a shift that cosmetically would help to depress inflation. Energy prices, if we break down price indices, are the anchor of high inflation, and in this respect getting the oil price down is as much a test of America’s diplomatic power (over OPEC) as it is monetary policy.

This is just one factor that, as the ‘recession’ chorus grows in the media, will contribute to an increase in tension between politicians and monetary policymakers over inflation. In the USA the Federal Reserve has dampened the economic risks associated with the Trump presidency, whilst the aftereffect of this (high inflation) has dampened the approval ratings of President Biden.

As such, one offshoot is greater public tension between central bankers and politicians (who having blamed Putin for inflation will find other scapegoats), with a low probability event that Powell is not in his role by December, against a backdrop where with inflation and crime are the leading issues in the mid-term elections in the US. In Europe, Christine Lagarde and colleagues will find that markets test their credibility to the extreme.

This trend will map out across other countries, where climate damage and high food price inflation (and availability) will create political stress. Sri Lanka, Egypt, Ethiopia, and parts of Latin America are likely victims.

We have noted several times that it is noteworthy that governments that have experienced the political effects of inflation in the past (France with the gilet jaunes) have already done much to curb the impact of higher prices on their populations. Large country governments may try to become more involved in resolving supply chain blockages (German supermarkets have started rationing purchases) and countries like Venezuela might find that it is drawn back onto friendly terms with the US. Equally, another surprise may be that the US threatens to remove its security ‘umbrella’ from Saudi Arabia.

Perhaps the most long lasting effect of inflation is to undermine confidence in economic policy across the board, and to give the sense that ‘no-one is in charge’ and in turn this may undermine confidence in institutions (like central banks – the logical extension is that bitcoin should become a real store of value and not a Nasdaq tracker).

One important outlier in the inflation story, that in turn demonstrates how the military and financial worlds are interrelated, is the war in Ukraine. Whilst it has arrived at a tactical stalemate, the war still poses tail events – namely the prospect of a negotiated peace or of a Russian strike on Western troops in Poland for instance. Strategically, it is likely the end of the Putin regime as a credible power (to the extent that his use to China is to learn from his mistakes).

What will be interesting however is to see how much progress is made on the longer term strategic trends that have been unleashed by the war – notably the upgrading of Europe’s armies, the coherence of European foreign policy and how in particular it manages an emboldened Eastern coalition of the Baltic states, Czech Republic and Poland, and the speedy move towards renewables (and some dirty energy). We should also discover the true intentions of the US with respect to Russia – whether it supports a war of attrition to politically disarm Putin, or whether it opts to support a diplomatic solution.

Much of what I have said is quite gloomy, but that reflects the state of the world, in a context where globalization has come to an end (David Skilling of Landfall Strategy – we do strategic advisory work together for firms/governments/investors  – has another excellent note on this here).

A hopeful scenario is that by November many of the inflation/monetary policy imbalances are pared back (China’s economy is an important factor too) and that markets enter into a long period of calm. In turn this will bring to the fore many of the more exciting fields of innovation – medical technology, green tech and biomed for example. That would be something to look forward to but we have a choppy summer ahead first.

Have a great week ahead,

Mike 

Tomorrow evening I fly to Dublin, which I am looking forward to (Cork would be better though). It’s the return journey that terrifies me. Dublin airport, owing to poor management, has subjected passengers to six hour long queues to board planes in the latest example of logistics chains gone awry because of labour shortages and general lack of foresight. In other parts of Europe, the UK and the US, travel is also proving problematic, such that many may think even more carefully about how and when they move around.

It is likely more daunting for people relocating to new countries. In general, the past four years have seen the climate for those wishing to migrate become harsh, the latest example being the Johnson government’s extension of its ‘asylum’ border to Rwanda.

Migration is one of the yet unanswered puzzles in the debate on globalization – other indicators point towards an end of globalization as we know it and a trend towards a more bordered world. Cross-border investment is becoming more regional and trade is too, the flow of ideas around the world is curtailed and within many countries it is polarised. At an institutional level, coordination between countries has become more problematic.

Yet, owing to the strictures of COVID (over 120,000 movement restrictions have been imposed around the world from the beginning of COVID to this February) we do not have a clear picture of what patterns in migration data look like – most data come with a significant lag. However, some estimates put the decrease in familial migration across borders at close to 35% and in general cross border migration in 2020/21 was at its lowest since 2003. Student migration (to the US and UK) has fallen by around 50%. More troubling was the fact that migrants in countries like Saudi Arabia were amongst the most exposed to COVID and to unemployment.

To that end, the role of migration as a factor that will confirm or reject the end of globalization is still hypothetical – but there are factors to watch for.

To start with most ‘visited’ countries for migrants, are the US, Germany and the UK in the developed world, and Saudi Arabia and Russia in emerging markets. Cities tend to be the locus for most immigrants – 25% of workers in German cities are ‘foreign born’. To that extent a reinvigoration of migrant flows should see more workers from Spain, Portugal, Algeria and Morocco come to Paris and Bordeaux, and more South Americans to Dallas and Miami for instance.

In particular, cities are poles of attraction for elites. A German scholar Max Schich has tracked centuries of data to show how Europe’s cultural elite have gravitated to and from key cities – Rome to Paris to Amsterdam and London. Today, perhaps the most interesting trends in this regard are the movement of entrepreneurs from California to Texas, and the role of Dubai as a locus for Russian and Indian business people.

There are some important faultlines, Brexit being a case in point where there has been a sharp drop in EU nationals working in the UK (147,000 left in 2020), with these replaced with migrants from non-EU countries like India, though net migration into the UK is at the lowest in over a decade. Hostility to migrants and refugees from policymakers is one of the uglier faces of the post Brexit political landscape in the UK, though it is not exclusively a British phenomenon. Eric Zemmour’s catcalls are an example.

In the context of globalization, a rough rule of thumb I have is that when the migrant (foreign born) population of a country reaches say 15% of the population, integration becomes a decisive factor. There are not many countries that manage to smoothly integrate more ‘foreign born’ than this (Switzerland is one) and it also seems to be a threshold that sparks a negative political reaction. The test for globalization then is whether developed countries have reached the political and economic limits of migration, to the extent that the flow of people into them becomes more controversial, or whether cities in particular can continue to welcome people from overseas.

Refugee flows from Ukraine will play a big role in this debate, and could to an extent crowd out flows from other countries (Iran, Syria for instance). As is now apparent, Russia’s invasion of Ukraine is producing economic side-effects that are making life in emerging countries more difficult (inflation in Turkey is 73%).

To that end, the issue is to what extent climate damage and food shortages lead to population displacement (from East Africa for instance) and coupled with political instability (Venezuela is the prime example where millions have been displaced). The wild card here is Latin America, where surveys (UN) show a huge amount of people across Latin America who express a willingness to migrate (focusing on the USA) because of corruption, high food prices and shortages and political instability.

The beginning of globalization unleashed flows of people (with remittances following in their wake) around the world, mostly to developed countries and their large cities. COVID, and a political-economic backlash have halted these flows, and the invasion of Ukraine has introduced an entirely new variable into the equation. Where people move to, where they are permitted to move to will shape the next phase of globalization.

My sense so far is that migration is becoming more bounded (notably from Africa to Europe), more regional and with a greater emphasis on cultural assimilation. We will likely enter a period where migration is more within countries and regions, less across borders – in that sense it is less ‘free’. At the same time, migration is becoming both more politicised (by Belarus and Russia) and more forced (by climate change and inflation).

Have a great week ahead,

Mike  

Imagine if some of the key patterns in our lives, the length and nature of the seasons for example, were to change. With mounting climate damage, that may well become the case. In other aspects of human life, such as longevity and the length and form of the working day, long established patterns are already changing – on balance we will live longer active lives, and work continuously, from home.

Another deep-seated change is the business cycle. There are not many people who spend time thinking about the business cycle, given it is a dull corner of economics, but the ebb and flow of the cycle affects us in a fundamental way, through pensions, jobs, investment and wealth.

In recent posts I have mentioned the business cycle a few times, in the sense that the rhythm of the business cycle may soon change, and I want to expand a little on this now.

To put this in context we have, by the benchmark of history, lived through an abnormal period over the past thirty years in that it has been characterised by three of the four longest business cycles in modern history (back to 1870 according to the NBER). Starting in 1990 with the fall of communism and the rise of globalisation, they have stretched for an average of 120 months, twice the long-term average. If we go further back in history, using mostly UK data, business cycles have tended to be even more jumpy.

Indeed, these staccato’d business cycles were driven by factors such as poor harvests (1880), wars (Napoleonic wars) and credit crises (1870’s) – each of which is problematic today. In that context, my hypothesis is that the world economy will rejoin the rhythm of shorter business cycles, for the following reasons.

The first, as regular readers will expect, is that globalization is broken. Many of its component parts such as long-run secular trends in technology, the export of deflation from China and a settled geo-economic climate, to name a few, were drivers of long periods of expansion. Now the boons of globalization – low inflation and rates, geopolitical stability and fluid trade/supply chains – are all being reversed.

A second reason is that the latter part of the period of globalization has produced a series of imbalances. The next ten or so years will be marked by the unwind of these imbalances. Specifically, there are three that I would flag – central bank balance sheets and monetary policy in general, international debt to gdp levels and climate damage. The correction of these imbalances will be one of, if not the defining pre-occupation of policy makers this decade.

Central bank balance sheets are, from next week with the advent of ‘QT’, going to begin a difficult contraction, the result of which will be a sharp negative wealth effect, the return to ‘normal’ of markets in the sense that they provide much better, realistic signals about the state of the world. One side-effect is that credit markets will work better, there may be fewer zombie companies and better allocation of capital, though the likely effect of this on the business cycle will be to have a shortening effect.

In turn, an environment where inflation and interest rates are ‘less low’ debt becomes harder to manage, and in emerging markets there are already mini debt crises brewing. One rather dramatic hypothesis of mine is that in 2024 (the centenary of the 1924 debt crisis) we have a world debt conference that aims to reduce debt levels through a grand programme of restructuring and forgiveness. Such a conference might only be necessitated by a 2008 style crisis – which at the current rate is not beyond policymakers.

That’s a dramatic scenario and a more likely one is that the burden of debt across countries and companies makes a repeat of the long expansion cycles of the recent past a difficult act to follow.

Sticking with debt, a favourite comparison of mine is between the rate at which the climate is warming (percentile ranking of recent world average temperatures) and rising indebtedness. Both are symptoms, not so much of globalisation but rather of unsustainable development – in both cases near existential risks are mounting, and there is a failure of collective action to deal with them. So, just as the world economy recovers from the 2024 debt crisis, it will tip over in the 2028 climate crisis.

Enough doom mongering but I do want to focus on collective action. In the recent past the large developed and emerging economies of the world were synchronised in two ways. First, structurally in that the West provided capital and consumption while the East brought manufacturing. This is now disrupted – in very broad brush terms, the west wants to reshore, while the east is happy to consume the goods it makes, and increasingly to enjoy its own wealth.

Second, policy across the blocs was coordinated, or at least there was a sense of openness and fluidity of policy discussions – the Plaza Accord is an early example, as is the ‘Committee to save the world’ that brough the Asian crisis to a close and then the G20 intervention in 2008 is another. Today, China and the US are barely on speaking terms, and the idea of strategic autonomy means that Europe increasingly needs to look out for itself.

A final complexity for the business cycle is that so many aspects of economics are changing – the nature and structure of work, the troubling trend in low productivity, the economic drawbacks of high wealth inequality and the way in which the notion of strategic autonomy will warp investment trends. This makes for much economic noise, and my sense is that all in it adds up to a world where the business cycle is incessantly disrupted and where businesses and policy makers need to think in terms of four rather than ten year business cycles.

Have a great week ahead,

Mike

Simon Kuper has another, good book out, called ‘Chums’ which explains how Oxford, and specifically its debating society the Oxford Union (as well as some related clubs like the Oxford Conservative Association) have created an eco-system that has funneled its members into a near monopoly of political power in the UK, and most dangerously of all has supplied the protagonists of Brexit.

Part of Kuper’s argument is that the Oxford Union – a very good number of whose presidents (e.g .Johnson, Gove, Hague) have gone on to senior political roles – is a kindergarten for Westminster politics.

I picked up a copy of the book on Thursday.

What made this purchase interesting was that I bought the book in Oxford, on my way to speak at the Union, but more about that later.

An interesting and important theme that emerges is the labour market for politicians and the impact of this on decision making. When you see the manner in which the Oxford Union debating chamber resembles the set up at Westminster and indeed the way in which the Union building, like Westminster, offers bars, libraries and meeting rooms that could foster conspiratorial behaviour, it is no surprise that budding politicians are drawn to it as a forming ground, and in turn that the networks made there have such an impact at Westminster.

In other countries, aspiring leaders follow channels also – notably Harvard, Georgetown and Yale Law in the US, and ENA (École Nationale d’Administration) in France. In many other countries – the US, Asia, Greece, Ireland and Spain for instance, families form the training ground for young politicians and seats are often passed through generations (a much less egalitarian approach).

The outsized role that the Union plays in British politics betrays the fact that unlike other important professions such as the military, the Church and medicine there is no training for politicians – at least in the UK. France as mentioned has ENA which turns out well formed technocrats, and in the US the fluidity with which people can pass from professions (law, Wall St, public service, the army) into politics means that elected representatives come to politics with a good degree of experience.

The tendency then is for the stereotyped Oxford educated politician to favour form (wit, speaking ability) over attention to detail, an approach that was evident through and beyond Brexit (though Olly Robbins the UK’s original negotiator was also an Oxford graduate).

One solution then would be a British ENA, and notably in the 1990’s I recall a group of left leaning Oxford academics (Roger Undy the labour economist for example) organizing courses in change management for the members of the future Blair cabinet, and to an extent the Blatvinik School at Oxford does this now.

The idea of a school for politicians, at lease in England, seems fanciful because the ethic of British politics is that policy is best left to civil servants and parliament is for entertainment. The flaw in this argument is that the civil service – from the Treasury to the Foreign Office – has been increasingly run down, denuded and bullied by politicians (Priti Patel and lately Jacob Rees Mogg). This produces a policy, ideas and implementation wasteland.

The majority of university graduates who might have been attracted to the Treasury or Foreign Office see this, and instead opt to work in industry and this, rather than the lying and braying of the current Tory elite, is the real emerging structural flaw in the British system.

Back to the Union. When I was a student at Oxford the Union was not quite my scene, though I remember seeing some memorable speakers there, like Lech Walesa and Imran Khan.

This time, I was surprised at how young the students looked (its really that I am much older), and expect that they are a much more diverse, balanced and sensible group than the Union Committees of the 1980’s, but probably less entertaining at the same time.

I enjoyed my evening at the Union, though disappointingly for someone who cares about the risks of ‘the end of globalisation’, our argument (Colin Yeo, Paul Donovan and myself) that ‘this House would abolish borders’ was rejected by the Union membership.

As a cheeky end to my story of the Union, if you want an alternative, ribald view on what life at an Oxbridge college should be modelled on, then have a look at the tv series based on Tom Sharpe’s excellent ‘Porterhouse Blue’.  

Have a great week ahead,

Mike