The Diplomacy Crash

US stock market valuations have only been as high as in 2001 and 2020, market concentration is more extreme than in the late 1920’s (the top ten companies now make up 38% of the market capitalization of the S&P 500 index), and money manager surveys show US households to be the most bullish on future returns from equities since the survey began in the early 1980’s.

So, given this precarious euphoria, when is the crash?

My response is that crashes come in unexpected places and times and one idea that has not had much coverage but that might become current is the idea of a ‘diplomatic crash’. By this I mean that a host of countries have invested diplomatically, or in terms of soft power, in institutions, partnerships and causes. The acceleration of a multipolar world by the second Trump presidency will crash the value of many of these diplomatic investments.

An example might be the ‘special relationship’ between the UK and the US, the seeds of which were sown by Roosevelt and Churchill during the second world war (Churchill coined the term in 1946), and later cultivated by Thatcher/Reagan and then the Bushes and Clintons with both John Major and Tony Blair. Today, it is very hard to see any personal chemistry, or philosophical common ground between Donald Trump and Sir Keir Starmer. If the ‘special relationship’ were a stock or even a crypto coin, its value would be at a historic low.

In more detail, the idea of the ‘diplomacy crash’ came to me the night before I voted in Ireland’s general election. Ireland is a very quirky, even eccentric country from a geopolitical view in that unlike many other European countries there is close to no debate in Irish politics on defence and security, and its defence capability is miniscule compared to benchmark countries like Norway and Sweden.

In that context Ireland, like many other mid-ranking developed countries, is about to suffer a diplomatic crash. It has, correctly, invested heavily in the UN and the rules-based order. Some of the pillars of this order, like the World Trade Organisation – effectively built by an Irishman (Peter Sutherland) – are in a state of dereliction. It may well be the case that the UN ceases to be effective in dispute resolution between states, world health policy and great power coordination.

In addition, together with Spain and Norway, Ireland has spent significant geopolitical capital supporting Palestine (all three countries recently recognized Palestine as a state). Here, it cannot be ruled out that a grand peace deal is made in the Middle East, between Israel, Egypt, the UAE and Saudi Arabia, whose goal is to create greater investment and commercial flows between these countries and strategically disable Iran, but whose outcome is to render the ‘two-state’ solution unachievable. This new, harsh reality would leave the humanitarian led foreign policies of many European countries well ‘off-side’, compared to the stance of the Trump administration.

Ireland is just an example here, and there are plenty of other crashes in diplomatic capital – Germany’s trade policy with China, and potentially Japan’s relationship with the USA, France’s relationship with Africa and in general the cultivation of the rules-based order by democracies.

In finance, when a market crash occurs, investors become structurally risk averse, run for safe assets and generally retract positions. This might be the same in diplomacy. The risk then is a more unsure, less engaged diplomatic world, and worryingly one where the international rule of law is ignored.

In Europe, reflecting the lessons of the euro-zone financial crisis, this may imply that EU foreign policy becomes more consistent across countries (though perhaps not yet unified) and more focused (Katja Kallas is perhaps the most forceful foreign policy chief that the EU has had). In addition, new policy coalitions and leadership groups will form, notably so in the case of the Nordic and Baltic states on defence and immigration.

The EU also needs to stop geopolitical hedging by its members. Hungary under Viktor Orban has become notoriously close to Russia, and whilst Serbia had tried to play both sides it seems more comfortable as a bona fide EU nation (it is an accession state).

Once Ireland’s election result is clear, the first task for its leaders may be to choose sides – solidarity with Europe and active participation in the EU defence effort, or a singular, eccentric relationship with the Trump administration.

 Have a great week ahead,

Mike

Profiles in Courage

John F Kennedy, who died this week 61 years ago, is famous for many things, but a lesser known accomplishment is that he won a Pulitzer Prize for a bestselling book entitled ‘Profiles in Courage’, that told the stories of eight American political figures (mostly senators if I recall) who took morally courageous stands on issues that went against the views of their parties and popular opinion. An example was John Quincy Adams’ decision to break from the Federalist Party (over foreign policy).

Like all things Kennedy, the book was a dazzling success, but also had a few magical ingredients. It is generally accepted that Ted Sorensen, adviser and speechwriter to Kennedy, contributed much of the book, or in his own terms, he wrote ‘many of the words that made up the sentences’. Equally, the book did not make it through the formal entry process for the Pulitzer, but was nudged into the competition by Joe Kennedy, the president’s father.

As an aside, in the context of the recent presidential election, it could well be argued that Joe Kennedy was a Trumpian figure…or that Trump is simply following the ‘Patriarch’s; example (David Nasaw’s book of this title is very good). Joe Kennedy accomplished more as a businessman than Trump, but fell short in his political career. Instead, he groomed Joe junior(killed in the second world war), then John, Bobby and Ted.

One of Joe senior’s achievements was his appointment as American ambassador to the UK, but his term was cut short because of his perceived stance on appeasement. With some irony, Joe senior had encouraged the publication of his son’s Harvard thesis as a book.

‘Why England Slept’ queried the ‘soft’ stance of the British government towards Germany in the lead-up to the war and argued that if Britain had re-armed earlier and taken a more robust stance with Germany, the second world war may not have happened, or at least might have taken a different path (the book was a great success and the British royalties were given to the city of Plymouth which had been badly bombed by the Luftwaffe).

Though Robert Kennedy junior may now take the ‘Kennedy’ limelight, the message of JFK’s books echoes in today’s world. In a couple of years’ time, someone might write ‘Why Europe Slept?’ in the sense that Europe has let its guard slip on security and not built defence infrastructure to keep up with the threat of Russia.

In a week where a Chinese vessel is suspected of cutting a telecoms cable between Germany and Finland, when the first EU defence and space commissioner has been confirmed (Andrius Kubilius’ first task is to compile an inventory of Europe’s defence supply chains) and where an intercontinental ballistic missile has apparently been used on Ukraine, there is a sense that Europe is still not ready for the worst.

The idea of ‘profiles in courage’ is even more pertinent. In a multipolar world, where countries and companies have to ‘take sides’, where America will arguably become more transactional and less relationship driven in its foreign policy and, where democracy is being eroded from within and afar, moral courage will be at a premium.

One unfortunate example here is Olaf Scholz’ moral capitulation in calling Russia’s president last week, ostensibly to lay the groundwork for a peace deal. Scholz likely had the upcoming German elections in mind, but his call was rewarded with an intense bombardment of Kiev.

This has left Scholz even more discredited. Up until this week there was now a growing debate around his future as SPD leader and the prospect that he could be replaced by Boris Pistorius, the popular defence minister. Pistorius has declared that he does not want the leadership tole.

This is a pity for Germany, because having Pistorius in place as Social Democrat leader by the time of the election might boost the party and would also make a coalition with the CDU easier to form and more ideologically consistent. As it stands, the polls show the CDU/CSU with some 32% of the vote, the SPD on 16%, AfD at 19% and Sara Wagenknecht’s party at 7%. At that rate the CDU-SPD coalition might need to take on a smaller partner, but in effect Merz would be the dominant partner.

A Merz lead coalition could be a real change for Germany, could reignite its economy and remake its energy policy, and may turn it into a more robust geopolitical player vis a vis Russia.

My advice is that Merz, and his compatriots at the head of the SPD both read the works of John Kennedy. 

Have a great week ahead,

Mike

Distance

If any readers travel to Singapore, I can recommend they visit the Botanic Gardens to sense the dawn break. A badly adjusted body clock brought on by jet lag meant that I found myself jogging around the Gardens at 5.30am on Monday and Tuesday mornings – uplifted by the sounds, smells and sights of this mini paradise.

My few days in Singapore, principally to speak at the Founders Forum gathering, allowed me to gauge the Asian reaction to the prospect of a second, more menacing Trump term in office.

I did so armed with the memory of a May 2016 visit to Singapore where I had asked a gathering of some 300 people to compile a word cloud (using their mobiles) of thoughts and emotions they associated with Donald Trump. The result was harsh, and very few of the participants that day thought Trump would be elected as president in 2016, and just as few thought that Brexit would happen.

To my mind the event was emblematic of the certainty of the era of globalization, and the ways in which this was smashed by events like the first Trump presidency, Brexit and the smothering of Hong Kong’s open society.

Singapore is one of the most important places to observe these changes from – it is highly globalized (the DHL Connectedness Report highlights it as the most globalized country in the world), delicately balanced between the Chinese commercial and American worlds, and institutionally one of the strongest countries (though it is one tenth the size of County Cork, it has an active army nearly ten times the size of that of Ireland). As a leading ‘micro-power’ it has an even greater stock of soft power.

As such Singapore will acutely feel the rising tensions between China and America especially in terms of the technologies it uses, investment flows and diplomacy. For context, the soon to be secretary of state Marco Rubio has laid out the faultlines in the relationship between China and America in an interesting document entitled ‘The World China Made’.

Indeed, several prominent politicians in Singapore such as prime minister Laurence Wong have declared the end of the ‘golden era of globalization’. My guess is that in the Trump era, Wong and colleagues will have to tread incredibly carefully diplomatically. Economically, it is clear that Singapore’s role as the wealth hub of Asia, or its ‘Geneva’ is gathering pace, and also obvious that its economy is benefitting from the growing prosperity in countries like Indonesia.

There are two other aspects of my visit that are worth stressing, less for what they say about Singapore but more for what they tell us how the ‘West’ is perceived.

First, with regard to Europe, in two separate meetings I was asked if I thought the euro would survive. This greatly surprised me as not only do I think the euro is a solid, though not yet perfectly formed currency, I have not been asked that question in Europe in nearly ten years. It suggests that Europe still has a reputational problem, or that at very least its ‘message’ is not reaching Asia. Conversely, it seems that there are too few Asian voices in the European media – connecting us to what is happening in cities like Singapore and Hong Kong.

The second reflection, which also resonates across Europe, is that for the first time in at least a century, an American presidency is being launched that has a manifestly threatening and aggressive stance towards the rest of the world.

America has historically been the builder of relationships, alliances and institutions (Pax Americana) and its (soft) power has been built on this. The tenor of the Trump cabinet is increasingly clear, and many of the appointees appear to have been selected on the basis that they did bad things in the past, or that they are prepared to do bad things to others in the future.

This is the great unknown for the USA, that its new posture towards the rest of the world causes it to lose influence and friends. 

Have a great week ahead

Mike

Empire

Donald Trump will be president of the United States for a second time, defying those who thought his first term was an anomaly and who considered that the American people still care about the rule of law. He will preside over the 250th anniversary of US independence, the next Olympics and World Cup.

This is an election result of such great consequence that it will decide whether America’s hegemony is renewed, or that its empire fades like so many others have done through the ages. Fittingly, I woke up to the news of Trump’s victory in Vienna, a city that knows a thing or two about empires. In that context, an interesting and possibly underread book is ‘The Hapsburg Way – 7 rules for turbulent times’ by Eduard Habsburg, known formally as the Archduke of Austria and now a career diplomat for Hungary.

Of Habsburg’s seven rules, the most important are ‘Believe in the empire, and your subsidiarity’ and ‘Respect law and justice’. Trump will likely not do well on these counts, nor does he score on ‘Be Catholic’ though the Catholic church has chased his coat-tails through the electoral campaign. He does better on ‘Get married and have many children’ and ‘Be brave in battle’.

The book is full of interesting snippets, such as that the first governor of Texas (in 1691) was installed by the (Spanish) Habsburgs. In that respect the only blemish in the book is the foreword, written by Habsburg’s boss Viktor Orban, who this week held court over his European counterparts in Budapest, in the wake of the Trump victory.

While I think that Trump will be much more disruptive for Asia and Europe, and that his presidency will see an unprecedented re-shaping of the Middle East, a great deal of media attention is devoted to his impact on Europe and NATO. Overall, the reaction is far too alarmist and the vision of world leaders cowering before Trump gives little acknowledgement of his and America’s vulnerabilities.

Despite this, with near comic timing, only hours after Trump’s victory was confirmed, the squabbling German government fell apart, a development that has been simmering for some time.

Germany will likely have an election next March, and this is good news. Scholz’ ineffective and indecisive government will be thrown out (Scholz may also be replaced by Boris Pistorius at the head of his party), and Germans will vote in a centre-right government, if polls are to be believed. There is very strong appetite on the part of German businesses to restart the economy, unblock planning laws and rethink energy policy. This much was very clear to me when speaking with investors and businesspeople in Hamburg (after Vienna).

If a new centre-right government transpires in Germany, this should re-engage the political engine at the heart of Europe between France and Germany. But there is a small chance that Emmanuel Macron will not be president of France in a year’s time. Macron, who this week compared Europe’s fate to ‘herbivore in a climate of carnivores’, is fantastically unpopular in France and it cannot be discounted that the Rassemblement will try to bring him down in 2025. Similarly, there is a risk that far-right parties in Europe are emboldened by the Trump victory.

Apart from the travails of the German and French leaders, there is a shift of power going on across Europe – in favour of Poland and Italy, and towards the Baltics/Nordics. The sense is that a Trump led US will bring about the end to the Pax Americana, which may initially leave Europe more vulnerable diplomatically, though ultimately it will become more independent (to America’s disadvantage). Arguably the loser here is the UK, stranded offside the EU, and at odds with Trump and his vice-president.

A Trumpian America, if true to the caricature, will leave Europe as the last bastion of democracy and independent institutions. This is a great challenge and one that most people are not ready for. In events I speak at, a trick question I pitch to the audience is to ask how many of them (usually accomplished, educated people) would enter politics – in most cases there are few volunteers. If European democracies are to be renewed, politics must re-civilise itself and to quote Eduard Habsburg, politics also needs more brave people.

Another area to watch is institutions. Donald Trump already politicized the Supreme Court and might well do the same with the Federal Reserve. On Thursday the Fed, oddly in my view, cut rates, but the press conference after the meeting was dominated by Chair Powell denying that he would resign if Trump requested, he do so. As America’s institutions may become more politicised, and world institutions like the UN and WTO become less relevant in a Trumpian world, Europe needs to ensure that the independence and competence of its institutions is pristine.

Returning to the topic of defense, perhaps the most interesting confirmation hearing (by the EU Parliament) of EU commissioners designate was that of Andrius Kubilius, the Lithuanian, first defense commissioner. His first task will be to deliver a paper (in 100 days from now) on the state of defense procurement, the integration of defense supply chains and the opportunities for a more intensive commitment to space technology. In his commentary, he revealed that a pan-European missile defense shield could cost up to Eur 500bn. So, we should brace ourselves for the issue of EU war bonds to pay for this.

To end this note with a very big picture view, in the context of the theme of the ‘Levelling’, Trump’s first victory was a wrecking ball to globalization. This second one shatters it completely and will try to remake America and the world order with a narrative and vision (‘tariffs’, ‘deportation’, ‘loyalty tests’) that will deglobalize. Politically, Trump has sold Americans a political vision based on the Leviathan (the people surrender their liberty to a singular leader in return for protection). Europe is still a ‘Leveller’ type system (bottom up democracies). Of the two approaches, I am with the Levellers.

Have a great week ahead,

Mike

No-one will save you

A headline in last week’s Guardian caught my eye. It read ‘No-one will save you’ and detailed the bubbling awakening of a volcano near Grindavik in the south of Iceland. Granted that we were in the area, we drove down to have a look. My family didn’t share my ‘lava-lust’ and luckily for them the police were still in place and roads to the volcano were closed.

However, the ‘no one will save you theme’ is also relevant to Iceland in the financial sense, in the way it represents a rare example of a small, powerless country that resolved its banking and debt crisis by itself, in a very painful but ultimately productive way.

Some readers may recall that in the mid 2000’s Icelandic entrepreneurs were making headlines with bids for leading British retailers like Hamleys and Karen Millen. That a small, fish led economy of some 350,000 people could produce such brash, adventurous capitalists has less to do with Iceland’s Viking and Celtic heritage than the over supply of cheap money from its banks.

At the time, Iceland vied with Ireland for the title of ‘biggest banking sector’ (relative to GDP). According to a presentation deck from Mar Gudmundsson, the Norwegian who took over as head of Iceland’s central bank post the crisis, the Icelandic banking sector grew by a factor of three times between 2004 and 2008. Specifically, Iceland’s banks, the likes of Glitnir, Landsbanki and Kaupthing (all AAA rated of course) were growing their balance sheets at a rapid rate (to a near record 10 times Iceland’s GDP) and bankers travelled from London to sell them new, genius investment ideas.

Like Ireland, Iceland became admired for its ‘model’ economy, and took advantage of the fawning of other Nordic countries and bodies like the OECD to sell more ‘Glacier bonds’.

There are plenty of colourful stories about the exploits of Icelandic bankers at that time, but to cut a long story short, when the global financial crisis struck in October 2008, the Icelandic banking system quickly collapsed.

As a small, open economy with meagre financial resources, the fallout was dramatic and painful. In the aftermath of the crisis, the Reykjavik stock market fell by 90%, the corporate bond market cratered and the currency (Icelandic krona, ISK) by 50%. Many households had borrowed in foreign currencies and as a result saw the burden (in ISK) of their mortgages soar. On paper, Iceland’s debt to GDP hit 700%.

A classic banking bubble was soon followed by a deep, textbook ‘bust’ (one economist Hermann Schwartz summed it up as ‘Iceland came late to the global party, drank too quickly, and hit the floor rather harder than larger economies’)

What is most interesting about Iceland is the way it resolved its crisis, largely by itself and through the will of the people. This might sound obvious or even trite, but when I compare it to the fallout from Ireland’s economic blow-up whose causes were very similar to Iceland’s banking crisis, Iceland has demonstrated a far greater degree of reform and accountability in its public life. In a world of heavily indebted nations the example of Iceland is one to bear in mind.

Like other European countries at the epicentre of the financial crisis Iceland was gripped by protests. Reform came quickly. The long-serving prime minister, Geir Haarde lost his job (his last speech to the nation ended with the words ‘God save Iceland’), and the governor of the central bank was forced out of his role.

The new government, and to a large extent the Icelandic people are considered to have largely taken ownership of the resolution of the crisis (think of the public opposition to pension reform in France as a counter example). Some thirty-six bankers were tried, sent to jail and fined, a development that is in stark contrast to other crisis hit countries.

Iceland suffered a brutal financial shock, and a deep hit to the real economy (output dropped 15% in two years), though this was ultimately less severe than the damage done to the Greek and Spanish economies, one reason for this being the manner in which the drop in the ISK made Iceland attractive as an exporter and tourist destination (the curiosity of tourists was also piqued by the explosion of the Eyjafjallajökull volcano and the use of Iceland as a location for Game of Thrones). .

A number of financial reforms also helped, the financial regulator was given extra powers, notably to protect deposit holders and new, domestic economy focused banks were created. The government refused to assume responsibility for debt owed to foreign nations and investors (many of whom were in the UK which placed Iceland on a terror watch list). Fiscal austerity was imposed, under the watch of the IMF, but this was less onerous in its conditionality than that imposed on Ireland, Greece and Spain.

The result of this reform and readjustment process was that the Icelandic economy began to recover some three years after the crisis started, and according to Iceland’s central bank GDP growth had caught up with the recovery of the US economy by 2018, surpassing that of the euro-zone.

Whilst it is a small, idiosyncratic economy, there are some clear lessons from Iceland in terms of how an open economy might deal with a multi-faceted banking, debt and currency crisis.

Very broadly, the key elements involve prioritizing the domestic economy, domestic banking  deposits and the free functioning of the financial system,  the sense of justice and accountability that comes from ‘regime’ change and the arraignment of guilty bankers, the absence of overly punitive austerity, and the presence of a stabilizing mechanism (in this case the currency).

As I write, Iceland’s economy seems to be thriving, with a new focus on biotech, geothermal power and climate-tech.

France, Germany and the UK should pay attention.

Have a great week ahead

Mike

Coherence

Kim Hong-Kyun is not a name that very many Europeans know, but they really should, given his grave diplomatic intervention last week. Hong-Kyun is the South Korean ‘first foreign minister’, who last week summoned the Russian ambassador to Seoul to register South Korea’s displeasure at the news that up to 12,000 North Korean soldiers are in or on their way to Russia to fight in Ukraine.

While North Korea’s contribution to the Russian war effort is already known (their armaments industry is producing as many shells as Russia itself – and more than all of Europe), the prospect of an Asian state sending soldiers to fight in a European country is unprecedented, and I am perplexed that European governments have not reacted to this (though South Korea, Australia and Japan sent representatives to a recent NATO meeting).

The South Koreans have pledged to arm Ukraine if North Korean troops fight there, raising the complicated prospect of an Asian proxy war in Europe – again something that would have been inconceivable years ago, and that also tilts us towards the notion of a world war.

Whilst some readers might find this an exaggeration, we are at a moment of coherence, when threads that have been developing over the years become clearer and begin to describe the contours of the emerging geopolitical order.

One of the notable formations here is the SCO or Shanghai Cooperation Organisation, which I wrote about in the Levelling (p. 245) describing them as a geopolitical ‘gang’ of the future and sort of anti-NATO coalition, or at least an anti-AUKUS group. Despite this, few of the university post-grads in international relations I have come across in recent teaching sessions knew of the SCO.

There is a sense that the shadow or the logic of the SCO was lurking behind last week’s BRICS meeting, given the perception that the BRICS is becoming an anti-Western alliance, which in reality is not true. Reinforcing this are the very different cultures across the BRICS countries, and the risk to their project that relations between them depend on individual autocrats rather than institutions or peoples.

Yet, a sign of the times is the manner in which large emerging nations like India and Turkey are hedging their bets in the sense of maintaining good relations with Russia and the US. For India in particular, the BRICS meeting was a chance to begin to repair relations with China.

They could be forgiven for doing so granted the impact that the outcome of the US presidential election will have on international relations. The choice is one between an effective continuation of the foreign policy of the Biden/Democrat administration in the context of growing pushback against American power, versus a Trump foreign policy that is unsure, opportunistic and likely goes against the deep grain of Republican foreign policy as established by Ronald Reagan, George H Bush, Colin Powell and Condoleezza Rice.

2025 will hopefully see the end of wars in Ukraine and the Middle East, following which the notion of the coherence of rival systems will come into sharper focus. It is increasingly clear that the leading autocratic states (Russia and China) are hell bent on undermining the democratic world, and any nations that toy with the idea of joining it (witness the heavy handed Russian interference in last week’s referendum on EU membership in Moldova, and it’s obvious interference in Georgia’s election which takes place this weekend). 

The danger is that the sharpening coherence of the SCO is like the development of AI – it has been gathering pace amongst specialists for some time, and then a public event (the launch of ChatGPT) brings it into the public domain.

One of the obvious casualties of the emergence of the SCO and indeed the geopolitical trials the world is suffering, is the diminished influence and credibility of world institutions like the UN and WTO (World Trade Organisation), which are being reduced to the role of bystanders in this emerging geopolitical contest.

The scene is set then for the November 5th election to either reinforce or undermine the world order.

Have a great week ahead, Mike

Act of Union

There is a theory abroad that the British Empire was so vast and dominant, simply because a large country (England) was attached to a brilliant small country (Scotland). It is true that many of the individuals we associate with the advancement of Britain are Scottish – economist Adam Smith, scientists James Watt, Alexander Fleming and Alexander Graham Bell, and writers like Arthur Conan Doyle and Walter Scott. More recently, some of the more prominent political figures in Westminster have been Scottish – such as Gordon Brown.

This year is the tenth anniversary of the Scottish independence referendum, which whilst the motion for independence was defeated, set in train a groundswell in favour of independence and the resulting electoral landslide for the Scottish National Party in the subsequent general election. At the time of the referendum, the SNP was led by Alex Salmond, who died last week, and who was the founding father and driving force of the independence movement (and a subscriber to this note).

At the time of the referendum, there was great interest in the prospect of Scotland going it alone, and the way the Scots might dis-engage their economy from England was the focus of attention. In many respects the downfall of the independence side was that they became mired in an argument over the kind of currency arrangement Scotland might have, and the resulting impact that this could have on household finances. In the land of Braveheart, this battle by spreadsheet proved too much.

The independence referendum also brought into focus the kind of socio-economic model that Scotland might enjoy, and this spurred me to start researching the model of small, advanced states, a theme I have developed in collaboration with David Skilling over the years.

Simply put, our thesis is that while the likes of Sweden, Switzerland, Singapore, Ireland and the Netherlands are culturally very different they, and a handful of other small states are all highly successful. Alex Salmond used refer to the northern most small, advanced economies as the ‘arc of prosperity’.

Small-advanced states dominate the lists of ‘happiest nation, ‘most innovative’ and ‘most open economy’, and share a common set of factors upon which their success is built (strong institutions, a healthy regard for the rule of law, prioritisation of education and innovation for example).

Indeed, this ‘secret sauce’ tallies with the work of the winners of this year’s Nobel Prize in Economics, Daron Acemoglu, Simon Johnson and James Robinson, the body of whose works links growth to institutions and laws (the book ‘Why Nations Fail’ is worth a read).

One of the first occasions that David and I presented our work was with Alex Salmond, in Singapore, and since then David in particular has been an active adviser to the Scottish government.

My sense is that the death of Alex Salmond, and the near implosion of the SNP amidst a series of leadership crises (and the resurrection of the Scottish Labour party who have increased their tally of Scottish MPs in Westminster from 2 to 37) will gravely diminish the political momentum towards an independent Scotland. On the other hand, the limits that Brexit places on the UK in general will serve as one of several motivators for the Scots to go their own way.

One of the underlying theses behind the small state model is that they are adaptive and strategic – nimbly ducking around the imbalances of a chaotic world. To a large extent this is still true – the Nordic countries, as well as the smaller Baltic states have impressively upped their game on the security and defence front (Ireland has not), and Sweden and Finland have thrown off their neutrality.

In addition, and a marker of how policy is changing in the Western world, the Nordic state – once a near parody of tolerance – are adopting much tougher stances on immigration, and after too much patience, organised crime. If they are really canaries in the coal mine of world politics, this turning point suggests that in Europe, there is now little welcome for an increase in immigration.

To that end, having been in the vanguard of economic advancement during globalization, small, advanced states are at the forefront of dealing with the challenges of an intensely geopolitical world.

Have a great week ahead,

Mike

From Cranes to Crypto

Madrid, Spain cityscape at Calle de Alcala and Gran Via

Regular readers will know that I travel a lot, always with a preference for boats and trains and by air when necessary. Having spent much of the summer without the need for a plane, the next few months will see an intensification of my travel schedule across Europe, the Middle East and Asia.

In most places I will be talking about the economics and politics of a changing world, but the virtue of visiting so many cities (Hamburg to Abu Dhabi for instance) and regions (the Cotswolds to South East Asia) is the opportunity it grants to witness the kinds of growth and development happening in the world, and the measures we can use to compare economic activity across countries.

Here, a few favourites come to mind. In the 1990’s and early 2000’s it was commonplace for economists and investment strategists in the large banks to rush back from trips to Asia with tales of how many cranes they had seen across the skylines of major Chinese cities and estimates of what this meant for the growth of the Chinese economy. Nowadays, those economists sit on a deck chair in the Marina Bay Sands hotel in Singapore, look out onto the bay and count the number of tankers anchored there as a proxy for global supply chain disruption.

Another tell-tale indicator is taxis. A former colleague, friend and reader of this note, with whom I used to travel to Japan in the late 1990’s referenced the length of taxi queues as a proxy for Japan’s then moribund economy (often unoccupied taxi ranks would snake around office blocks).

Then on a visit to a thriving Abu Dhabi in 2012, my taxi driver got lost (on the way to the airport). He apologised, saying it was his ‘first day’. I assumed he meant it was his first day as a taxi driver, but it turned out that it was his first day in Abu Dhabi. I politely took this as a sign of a vibrant labour market and a strong economy.

A risk that travelling economists face, not unwittingly, is that they normally stay in the centre of a city, and often in a decent hotel. I wrote a note some time ago describing this as ‘Grande Bretagne’ syndrome, after the teams from the IMF who oversaw the austerity programme of the Greek economy during the euro-zone financial crisis who stayed in the plush Grande Bretagne and Hilton hotels in the city centre. While this placed them near the seat of power, it meant that they were blind to the brutal impact of austerity across the country.

In general, travelling economists should get out and about. For instance, the quality of public transport in a country is a good indicator of the standard of infrastructure and to an extent, social cohesion and, is also a good way to observe a society. Someone observed that a city in which the wealthy use public transport is a well-balanced one (Zurich is a good example). In contrast, there is, inexplicably, no train from Dublin airport to the city centre, but a ride on the Luas tram will give a very good idea of the dramatic changes in Irish society.

In keeping with this approach, a favourite activity to beat jetlag and to either reacquaint with or discover a city is an early morning run (this week’s schedule took in the Tour Eiffel, the Tiergarten and Madrid (the park was closed due to bad weather)). In that idiosyncratic way, My eyes (and feet) are sensitive to the quality of the road surface, pollution and to the appearance of new buildings and signs of dereliction (Berlin scores on both counts).

There are other indicators of the economic prowess of cities, such as the rise of tall towers (the UAE for instance). In this tech driven age, a new category of indicators might comprise cities that want to become crypto-hubs (UAE, Miami, Zurich, Lisbon) and those that seek to attract large artificial intelligence (AI) firms (OpenAI has just opened an office in Paris).

As a final note on Madrid, I haven’t seen the city as ‘sleek’ or well presented (the 12th was the national holiday), and it must be said, as expensive. Note that Spain now has a slightly lower interest rate (bond yield) than France, and a considerably higher rate of growth than Germany.

The economy appears strong, despite concerns that many people versed about the state of Spanish democracy and its finely balanced political situation – there is likely a contentious budget on the horizon towards 2025.

There were a lot more Latin Americans than I had expected, and this has both helped tourism, and pushed up house prices (to the ire of some locals). Spain’s golden visa system means that it is the recipient of wealthier Latin Americans leaving countries like Venezuela. At the same time, quite a number of Spanish businesses and executives are relocating to Lisbon, which is a warning sign for innovation.

Have a great week ahead,

Mike 

Druk!

Winter it seems, across much of Europe, has come early. Two instincts that grow as the evenings darken are the inclination to have a tipple in the evening and to watch a good film. One Danish work that captures both sentiments is ‘Druk’ or ‘Another Round’, which won the Oscar for best international film in 2021. I recommend it.

In the film a group of four school teacher friends decide to test the hypothesis of a Norwegian psychologist that humans have a deficiency of alcohol in their blood, and the protagonists undertake an experiment to maintain a ‘warm’ level of alcohol in their blood. It is an experiment I attempt often, but the real lesson today is with central banking.

It seems that central bankers have decided that in the spirit of ‘Druk’, the liquidity in the world financial system is not sufficient and have set out to administer near daily injections of cheap money. The number of central banks changing policy (i.e. to negative) is the greatest it has been, apart from the global financial crisis and the COVID period. In September alone there have been 24 rate cuts from central banks around the world.

Chief amongst these has been the 50-basis point cut from the Federal Reserve and the very dramatic, multiple policy moves by China. In short China has cut rates, infused the banking system, made mortgages cheaper and generally tried to spread liquidity over the emerging cracks in China’s economy. In the spirit of ‘Druk’ it is the equivalent of going on a five day bender in order to cure a serious disease.

Nonetheless, the easing in policy from the Fed and China, together with what will likely be a couple of more rate cuts this year from the European Central Bank mean that the world financial system is flush with liquidity. Chinese markets – hitherto the worst performing markets of a major economy – show the impact and importance of liquidity. The market cap of the Hang Seng index has grown by a quarter in less than two weeks. China has overtaken the US in terms of equity market performance to date.

There is no change to fundamentals – I don’t see this policy move having a decisive impact on the downward trend in Chinese earnings, but that doesn’t matter in the near term – liquidity is coursing through the pipes of the Chinese financial system, and in turn might bring a temporary easing to conditions in the property market.

For all the analysts who devote time to measuring earnings and calibrating valuations, the reality is that in this era of ‘quick to please’ monetary policy, liquidity matters a lot for asset prices. My rule of thumb in constructing a measure of liquidity would encompass money supply, the state of central bank balance sheets, the key role of the dollar and net issuance of debt by treasuries.

The arcane notion of financial liquidity has attracted enough attention that the Financial Times recently ran an article breaking down its component parts. A couple of top-flight economics consultancies run their own measures of liquidity – such as LongView Economics and Michael Howell at CrossBorder Capital. The latter holds that we are on the cusp of a significant upswing in global liquidity.

 If that is true, the implication for markets is ‘Druk’- a persistent giddyiness whilst central banks keep rates low and liquidity flush, amidst an acceptable level of GDP and profit growth. Friday’s job market figures in the US were very strong, suggesting that in fact there was no need for a large rate cut. This is the kind of macro climate we have seen in the mid and late 1990’s, and one that tends to dampen the market implications of turbulent geopolitics.  

From the point of view of asset prices, there are a couple of possible trajectories. Historically, the Fed has started to cut interest rates when the price to earnings ratio on the S&P 500 has been close to 10 times (1960’s to 1990’s). Now, like in 2000, it is in the mid 20’s which suggests that extra liquidity now could run asset prices in bubble territory proper, and cultivate the next bout of inflation, something the central banks’ bank, the BIS, has warned about (helpfully the BIS has taken a counter view to that of its members ahead of a number of crisis).

For the time being, the upturn in liquidity may be most meaningful for capital markets activity and assets in the private economy. They have been in the doldrums. If the ‘Druk’ hypothesis is working we should see a rise in IPO activity into 2025, and intensification in private equity deals and a rise in funding activity (beyond AI firms) in venture.

Then, later in 2025, the hangover will arrive.

Have a great week ahead,

Mike

Another Tea Party?

The Boston Tea Party is an early example of how a trade dispute can reshape an economy (Boston) and foment political change. It is iconic enough that the first presidency of Donald Trump was prefigured by the rise of the Tea Party as a disruptive force in Republican politics.

With the presidential election not far off now, tariffs form the spear-end of Donald Trump’s economic strategy, potentially because he can implement them unilaterally (without the approval of the Senate). In addition, many of his acolytes, from Robert Lighthizer to Peter Navarro, are ‘trade’ obsessed, and have recently published books like ‘No Trade is Free‘ to underline the ways in which they would re-order the international trade system.

In addition, other members of the Trump entourage such as Robert O’Brien, the National Security Adviser (2019-21) has in the July edition of Foreign Affairs Journal invoked the idea that American can bring peace to a disordered world through ‘strength’. In this vision, strength comes in the form of 60% tariffs on Chinese goods and export controls, a message that has repeatedly been emphasised by Trump himself.

In that context, a second Trump presidency could begin with a trade war, and a verbal assault on the currencies of ostensible allies that have weakened in recent years, such as the yen. American consumers and potentially the bond market might pay the price of tariffs (we wrote last week that Trump wanted to fund the development of a sovereign wealth fund with revenues from tariffs).

Trade wars are generally not successful, and while Trump may have in mind America’s trade spats with Japan (1987), the weight of past trade disputes going back to the Smooth Hawley Act suggest that there are better ways to guard American economic power. China could respond with measures that cripple supply chains for at least a couple of years. In this scenario, a trade confrontation between the US and China would decisively shatter the axis of globalisation as we know it, and finally render the WTO (World Trade Organisation) obsolete.

A US-China trade war might have many other consequences.

One might be the rise of populous south Asian (and southeast Asian) from India to Bangladesh to Pakistan, Indonesia, Thailand and Vietnam, with Singapore as their organising locus. Many of these countries are urbanising and rolling out infrastructure, most of them need but distrust China, and in most cases aspire to closer commercial ties to the USA. Tariffs on China by the USA will accelerate supply chain de-risking by Western multinationals towards these countries, though this could well complicate their relationship with China.  

A second consideration is Europe. The EU has been caught by surprise by the consequences of several Biden administration policies – the Inflation Reduction Act and the CHIPS Act – which illustrates that US international trade policy is usually made with a view to domestic politics. A second Trump presidency should be no surprise to Brussels, and there is a small but important team of officials working on a policy response to a potential trade war on Europe by Trump.  Europe’s trump card may lie in its role as a partner with the US against China. It will be difficult for Washington to reshape trade relations with China, Europe and potentially Japan by taking each one on. Stymieing China is better done in collaboration with Japan and Europe, and Trump should really see the constraints of the policy situation that faces him.

A second Trump presidency will be different to the first in the sense that he has had time to prepare for it, and crucially, his supporters have had four years to concoct a policy strategy (‘2025’ seems to have dropped out of headlines). In the same way, a Harris presidency comes with deeper reserves of policy experts, and to a large sense on the international trade and economic outlook, the Harris case represents ‘more of the same’ in terms of the techn0-strategic economic policy that is currently pursued by the White House.

An idealised, and though I like the idea a lot, too lofty rendition of this policy is Walter Russell’s Mead’s September Foreign Affairs essay entitled ‘The Return of Hamiltonian Statecraft’ which argues for the very un-Trumpian notion of ‘enlightened patriotism’.

In this context, a Harris White House would use trade and investment policy to laser focus on America’s race with China for global supremacy. Driving Chinese economic and investment activity further inwards might be one goal, and ironically anything Washington can do to make Chinese public life more closed and repressive, the better (because it curbs innovation and wealth creation).

At the same time, the US and Europe, would both pursue parallel strategies of ‘strategic autonomy’ or what Trump refers to as ‘strategic national manufacturing’ focused on sectors like defence, new computing power (quantum, AI, data storage and management), batteries and new power sources and revolutionary medicine. Europe’s challenge is to find a way of reducing long-term energy costs.

Kamala Harris, who has trialled a few incoherent policies (taxes on unrealised capital gains, price controls) is likely to be more constrained in her fiscal policy – because her government is likely to instinctively focus more on tax and spending changes, for which she will need the help of the Senate (which in turn could tilt towards the Republicans). As such her fiscal policy will focus on not increasing the national debt, and like many other governments, encouraging the private sector to work with government to build out strategic technologies.

I am so far surprised that markets do not seem to price in uncertainty over trade policy, possibly because they are more focused on falling interest rates in the US, Europe and China. However, the next month will start to reveal how seriously financial markets take economic rhetoric of each of the presidential candidates.