L’Accord du Peuple

In February 2024 Pierre-Charles Pradier and I launched ‘L’Accord du Peuple’ (Calmann Levy), our argument to bring the apparatus of French democracy closer to the people, and in so doing avoid the stalemates and frictions that seem to convulse France. The book made the case for more participative democracy, greater power for regions, more transparency and accountability of local, regional and national budgets, and we also strayed into the debate on the corrosive influence of social media on politics.

A few months after the publication of the book, Emmanuel Macron’s party was handed a beating in the European elections and in a catastrophic unforced error Macron called a general election, from which he and his many governments have not recovered. During the hasty 2024 election campaign Pierre-Charles and I thought our moment had come but, it seems we had fooled ourselves, there is very little desire in Paris to surrender power to the people.

A lesson, for me at least, is that the roots of governance in France are deep and potentially go back to the medieval period – Paris is the citadel of power, where barons (Edouard Philippe’s ‘Dans L’Ombre’ is worth a read), ‘knights’ and janissaries serve and rise through the system. There is an intense homogeneity across those who populate the system, that is not found in other European countries like Germany. Though, in general as a process, the system works well, it struggles when it is required to change.

To that end, the notion that France is ungovernable (expressed widely in Anglo-Saxon countries) is wrong, it is over governed, and the system of the state excludes most French people. Recent changes to the political system, such as the removal of the ‘double mandate’ that ended a practice where local mayors could also serve as parliamentary deputies, have put more distance between local politics and Paris. Another observation is that France, compared to smaller European countries like Switzerland, Sweden and especially Ireland, is a very low trust country, and this element can make democracy harder to operate.

In that context, protests like the Gilets Jaunes reflected a view that the state is removed from the people. Since then, through the COVID crisis and the Olympic Games, there has been a remarkable degree of calm in public life, which has irregularly been punctuated by outbreaks of vandalism (e.g when PSG won the Champions League). Increasingly, what may once have been political protests, led and managed by unions, are now festivals of wanton violence, of which October 17^th is an example. There is still a large cohort of commentators in and beyond France who over analyse and philosophize the reasons behind the vandalism but, there is a growing public consensus that it is reckless, dangerous and damaging to France.

It comes as France has entered a ‘debt purgatory’ (our Barrons article in August set this out), and when the 2027 presidential race is vigorously underway. The seemingly unassailable position of Marine Le Pen reflects both the discontentment of French people with Emmanuel Macron and the ‘establishment’, and relatedly a widespread view that immigration/identity/integration is a political problem that has not been addressed. The strength of this view is such that it ignores Le Pen’s suitability as a candidate, her lack of experience, economic illiteracy and the potential friction that a Le Pen presidency would cause across Europe. Yet, the presidential race is a steeplechase, with plenty of obstacles (recall that this time in 2016 Francois Fillon was the favourite to win the 2017 election).

A Le Pen presidency will surely deepen France’s burgeoning debt crisis, and very likely produce a market event such as a run on the French banks. Such an event may be necessary to convince the French public of the need for drastic reform of their economy. Denial of the extent of the fiscal challenge remains strong.

In this respect, what is striking across the political spectrum in France, is how nearly all of the candidates operate in a restrictive view of the French economy as a redistributive system (tax heavily to spend hugely). This perspective ignores France’s economic strengths in innovation, production and engineering, but also condemns the country to a future of low economic growth. A truly revolutionary, providential candidate, if one is to arrive, would focus more on a complete rewiring of the French economy, though to my earlier point, I suspect that the system may not permit that.

Those commentators looking in at France from afar and drawing the conclusion that the wrecking of the country is yet another expression of French exceptionalism are very wrong. The worrying aspect is that France is simply a showcase to the two problems that beset the world, indebtedness and a crisis of democracy (three is we include the side-effects of climate damage). The US, China, Japan and the UK are as or more indebted than France. Britain has had six prime ministers during the time Emmanuel Macron has been in power. American democracy is faltering, and Washington is dallying with autocracy.

The ways in which individual countries deal with these twin challenges are central to the idea that the world order is in an ‘Interregnum’ phase and will determine the winners and losers of the 21st century.

Have a great week ahead, Mike

MidWay, the End, or the Beginning?

America’s midterm elections are not unlike local elections and by-elections in the UK and European elections across the EU – an often-dull event met with low turnout, but that nonetheless provides an important check on public opinion, guards against complacency by the incumbent power and helps to refresh the bloodline of politics (perhaps less so in the gerontocracy of American politics).

In this context, Republicans should bear in mind that in recent years local elections (UK) and EU polls) have proven consequential. An expected poor showing in last May’s local elections was reason enough for the Labour party to jettison Keir Starmer, while Emmanuel Macron’s foolish decision to call a general election following a weak result for his coalition in the 2024 European elections, sapped his government(s) of power and credibility.

In the US, the mid-terms have at times been fateful. In the November 5th, 1946, midterms John F Kennedy, Joe McCarthy and Richard Nixon all entered politics. In an echo of the debate on poverty in San Francisco today, and the Californian billionaire tax, the 1934 California gubernatorial election saw the Democrat Upton Sinclair (he was closer to a Democratic Socialist in today’s terms) launch a campaign entitled ‘End Poverty in California (EPIC)’. Business and landowners didn’t like this, and the movie studio bosses set against him and they spurred an attack campaign against Sinclair using fake newsreels. Upton lost to a colourless Republican in what was likely the first ‘fake news’ political attack campaign, but most certainly not the last.

In three weeks’ time, Americans will vote in a consequential midterm roster of votes. As I write, polls and prediction markets point to the potential for a Democrat upset in the Senate (65% probability). The House of Representatives already appears settled – the Democrats need three more seats for a majority but look like they might take up to ten. In the Senate, polls suggest that the Democrats will hold most of the contested ‘Blue’ states – Jon Ossoff will for example easily win Ohio. Then, it looks likely that we will see upsets in Alaska, Maine, Texas, Ohio and maybe Kansas. Since 1861 there have been 29 Republican Senators representing Kansas and only 3 Democrats, the last being in 1932.

As such, a swing to Democrats in Kansas would be emblematic of a major upset, and here there are many things at stake. The most obvious is that the midterms are a referendum of sorts on President Trump, the economic spillover of his war on Iran, growing financial polarisation and the conduct of politics. A very important consideration in the context of manifest corruption (recall that President Trump has promised USD 5,000 to Americans if his party is successful in the midterms) is the role of the democratic system as a check on executive power, and in this context a resolute vote against the President’s party and its many ill-chosen candidates, should be accepted as a sign that American democracy functions.

The midterms will also prove a steer for the next presidential election. A poor showing for the MAGA Republicans will surely dent the chances of the likes of Marco Rubio and JD Vance in 2028 and encourage the likes of Mike Pompeo and David McCormack. On the other side, if the likes of Abdul El Syed in Michigan are victorious, such a result might embolden the Democrats to present a Democratic Socialist presidential candidate in 2028 (a mistake in my view).

Into 2027, a Democrat held Senate might tilt policy in several ways. First, there may be an attempt to impeach ‘War Secretary’ Hegseth, granted the number of Republican Senators who disdain him and even, a move to impeach the President. It is likely that the Democratic Congress would seek to draw in the reins of American foreign policy, and potentially the rapid accumulation of debt by the President though it is hard to find Democrat fiscal hawks. In this regard, a potential market reaction may be a rally in Treasuries should the Democrats enjoy a successful mid-term campaign.

They are also likely to want to slow the build-out of data centres, and AI infrastructure in general, which as an economic activity is dwarfing activity in other sectors – be they manufacturing or construction, and has become a major focal point in state-level elections. Naturally, the emergence of such a policy across Congress would dent the speed of AI infrastructure build-out, which itself may not be a bad thing. But, the financial upshot is that a Democrat win in the Senate (and House) may be the catalyst to trigger a significant shift from US equities to bonds, and the President may well blame them for any resulting market volatility.

When the dust settles on the midterms, the 2028 presidential race will start.

Have a great week ahead, Mike

Ulysses, Opium and Electric Vehicles

Trade wars can have long-running, unintended consequences. The Smoot-Hawley Act of 1930, widely regarded as a catalyst to the Great Depression, contained a clause (section 305) that permitted the banning of obscene materials, a classification that (in the US) covered James Joyce’s Ulysses. Joyce’s publisher, keen to sell the book in the US, brought a test case under the Smoot Hawley Act (United States vs. One Book Called ‘Ulysses’), and the resulting verdict that the book was not ‘obscene’ made Joyce’s text a bestseller in the US and changed American obscenity laws.

A more serious case was the consequence of the Opium Wars, which ended with Hong Kong ceded to Britain, and began what China recalls as its ‘century of humiliation’, a perspective that still colours Beijing’s view of the West. In 1997, Chris Patten presided over the handover of Hong Kong to China, and in 2020 the introduction of the national security law drew Hong Kong legally, institutionally and politically back to China, with little protest from the West, and in my view, this is the defining event that marks the end of globalization as we knew it.

A key institution in the process of globalization was the World Trade Organisation (WTO), which in its early incarnation as GATT (General Agreement on Trade and Tariffs) enjoyed strong leadership under Peter Sutherand and later Pascal Lamy, but is now defunct.

Beyond its trade agreement rounds, the most consequential event for the WTO was the decision to admit China in 2001. The move was approved by President Bill Clinton at a time when there was an uneven power balance between the US and China and, at the time, Clinton described China’s economic relationship with the USA as ‘the equivalent of a one-way street’ (arguing that it was a highly attractive opportunity).

The trade, manufacturing and financial relationship between China and the West formed the basis of globalization, and it is the evolution of China from a provider of cheap labour into an economic powerhouse, together with the failure of the West to hold it to the terms of WTO, that has led to the breakdown of globalization. Indeed, many expected that the second Trump presidency would pick up where the first one left off, with a hostile trade stance on China (in 2018 Marco Rubio released a very hawkish report on China ‘The World that China Made’).

Now, Europe rather than the US, may be the one to pick a trade fight with China.

China’s growing prowess in technology, intense domestic industrial competition, coupled with large quantities of state aid for ‘champion’ firms, and the need to replace a deflating real estate sector with a manufacturing boom, have created a surplus in/of manufactured goods, which China has opportunistically dumped on the European market (known as the China shock 2.0), to the consternation of auto manufacturers, chemical producers and pharmaceutical firms in the EU.

Until very recently, the EU has permitted this to continue, for at least two reasons. The first is that EU trade policy is very product-focused in terms of its corrective measures, and the second is that there has been no strong consensus amongst the large European countries on how to deal with China. For example, in his 946 page memoir “La diplomatie n’est pas un dîner de gala’ (a play on Mao’s line that a revolution is not a dinner party) the former French ambassador to China, Claude Martin states that the lack of a coherent, watertight view on China by the EU (with policy measures to support), meant that China could divide and conquer across European capitals.

That is apparently changing. In recent weeks, commentators and industry bodies in the major countries, notably France and Germany, have been striking a bold and hawkish note on China, and this much was reflected in a major development with the issue of a letter by French and German presidents to the EC president, where they call for a much tougher stance on China.

In my view, there are three mistaken elements in the French/German stance, a lamentable view of Europe as the victim, a lack of urgency to get European industry to reform and become more competitive (notably few of the Draghi recommendations are in place), and third, the lack of an even more aggressive view on China in the sense that its economy may be even weaker than many think.

Diplomatically, the move is being presented as a ‘conversion’ by the two governments, each led by intensely unpopular figures (Macron’s ratings are at an all-time low and Merz’ is not far behind).

There are two elements to note in the letter, which aims to protect key European industries such as chemicals, pharmaceuticals and autos in particular. The first is a diversification instrument that will safeguard supply chains from over-reliance on Chinese goods and inputs, and the second powerful measure aims to exclude Chinese companies (China is not mentioned in the document but the sense is that it is very much the target) from the EU market where trade dumping produces severe and systematic distortions. The implementation of such a measure could be rapid and would need a majority of EU states to block it.

EU trade commissioner, Maros Sefcovic spent last week in China, trying to extract a commitment from Beijing to limit the flow of Chinese goods to Europe. My sense is that the polite apathy that greeted him (as I write there is talk of an agreement on are earths) means that China has little intention of striking a reliable deal, and that a trade confrontation between Europe and China in early 2027 is something European businesses need to prepare for.

Have a great week ahead, Mike

The Rotten Heart of Europe

One of the first books I read that helped to explain how Brussels worked was Bernard Connolly’s ‘The Rotten Heart of Europe’, published in 1995. It was a massive hit (in the UK) and hugely controversial. Indeed, a second edition came with a cover recommendation from the then editor of the Spectator Boris Johnson (‘one wanted to stand on the desk and cheer’).

The book did much to propagate Euroscepticism in British politics, and we might trace some of the roots of Brexit to it. With some irony, Brexit showed that the Commission can function in a forceful way when a crisis befalls it. However, as is well documented the challenge for the EC is to now step up a level and reinforce itself for a multipolar world where it will compete more acutely with China and the US, with at the same time Russia snapping at its heels.

Connolly’s book came to mind a week ago when speaking at an investment conference. I was joined on a panel by economists and policy makers from Italy, Spain and Portugal, so that together we made up a representative group of the euro-zone periphery countries hit hardest (though Greece suffered the most) by the euro-zone debt crisis.

Each of the periphery economies has had a remarkable turnaround – Italy is a bastion of political stability, Spain is the fastest growing of the large economies and Greece, Portugal and Ireland are arguably ‘too hot’ in terms of the rate of growth and price inflation they experience. What is telling is the signal from bond markets – yields for Italy, Spain and Greece for example, are below those of France and the UK, and Ireland is nearly on a par with Germany.

In that respect, the tables have been turned. It is not forgotten how Angela Merkel and Nicola Sarkozy upbraided the lazy Mediterraneans in the 2010’s. Now, the three large countries at the heart of European history – the UK, France and Germany, are struggling, and to unkindly borrow Bernard Connolly’s title, constitute the ‘rotten heart of Europe’

They share common problems – sluggish, low growth, an inability to foster sustained private investment, political instability in the face of electorates who are in thrall to the easy solutions of populist parties. The reaction to last week’s triumph of the AfD (Alternative fur Deutschland) in Saxony-Anhalt is an example, and it may mean that Frederich Merz suffers the fate of Keir Starmer should his coalition collapse or his party cast him aside in favour of a younger leader.

Though the tempo of growth is picking up in Germany, the UK and France, it will not rescue the leaders of the large economies. An additional complexity is that trading partners and allies are turning against them – China is exporting its manufacturing over-capacity to the German consumer and the special relationship that characterized US-UK diplomacy has all but withered away. The prospect that the White House might favour Argentina’s case for sovereignty over the Falkland Islands is a stunning case in point.

Unlike France, the British and German economies suffer from a similar failure to upgrade their ‘production capital’ – investment in research, skills, new technologies and to an extent, manufacturing capacity. Both are behind France in terms of military power, but France is a leader in over-regulation. The fate of these three great nations has already inspired an endless flow of analyses, ideas and suggestions – the best of which from Mario Draghi, seems to be ignored.

The sole thought I have to add, is that incumbent, centrist politicians in all three countries appear to ignore the increasingly obvious lesson that the rules of the geopolitical game have changed, and as we have referenced before in this note, we live in an ‘age of predators’, and consequently prey (Starmer). In this regard, new ideas are not the solution, but a change of method is. That method is more singular, less consensus led and aggressive. Edouard Philippe in France and Andy Burnham are its test cases, we will know by next May if they learn this lesson, and if not, Europe is in dire straits.

Have a great week ahead, Mike

Debt Purgatory

Roland Garros is one of the more stylish and elegant parts of Paris, and not a bad location to discuss finance and economics. Unfortunately, France’s political elite did not rise to the occasion. At the end of last week, (MEDEF), the large French business network gathered the principal candidates for the 2027 presidential campaign to listen to their views on the economy, and in particular their policies to pare back France’s gargantuan fiscal deficit and debt load. With a few exceptions, they disappointed. 

The candidates for the far-left (Jean-Luc Melenchon of La France Insoumise) and far-right, Marine Le Pen of the Rassemblement Nationale, appeared to treat the event as a light-hearted post-holiday chat show, and not a forum to debate the faultline that could pitch the euro-zone into another debt crisis. 

Though France’s presidential election is far off (the first round is on 18 April 2027), international investors need to pay close attention to it, both as a specific risk factor for bonds, foreign exchange and equities, and as a harbinger of what might befall most of the other major economies. 

In this respect, France has at least two things in common with the US. First, its weak finances. The budget deficit has been stuck at 5%, a level historically associated with a recession, and debt to GDP is on course to hit 120% according to the OECD. Second, there is no appetite to tackle this dire fiscal situation. In the US, there is little prospect of corrective tax hikes or spending cuts, and the Trump administration appears to have a fetish for intervening in markets.  

In France, three governments have been consumed by the process of setting a budget, and there is no political nor popular will to set France’s finances on a sustainable track. What is worse is that wild, populist suggestions that France could cancel the debt that the Banque de France holds (as a result of quantitative easing) are being aired in the media. France’s political class and populace are not known for their financial literacy, and the belief in some quarters that debt can be magicked away is dangerous and sets the economy up for a sharp reality check. 

Having witnessed the brutal effect of a debt crisis and the subsequent austerity on the Irish economy from 2010 onwards, French policymakers and its public are badly unprepared for what may come. Government spending at 57% of GDP is comparatively huge, and much of this goes on social welfare (healthcare and pensions). 

Unlike the US, France is not enjoying an AI capital expenditure fuelled wealth effect, and the notion that it might act to structurally boost economic growth is anathema to nearly all of its politicians. In a demonstration of moral hazard, France has accumulated debt at a pace and amount more than any other euro-zone country, without much protest from the ECB.

Markets however, are reacting. French ten-year bond yields have just passed Italy’s. While long-bond yields in Japan, the US and UK have all broken higher to multi-decade highs, the re-rating of France is troubling. For international investors, France’s changing status, from a core, safe haven, to a periphery market is one of several signals of a coming debt purgatory – a long period where indebtedness dominates markets, government politics and geopolitics. 

For European policy makers, the fact that France is the indispensable nation on geopolitics, defence and military innovation complicates matters because it means that politically, in the context of German underperformance, France is harder to corral into a fiscal straightjacket in the same way the European Commission did with Greece, Ireland and Spain. On the European political stage, there is no-one fiscally credible politician who might stand up to France and avert the potential for contagion across the euro-zone. 

If for instance, both Melenchon and Le Pen make it through to the second round of the presidential election, bond investors will desert France, French bank share will collapse, luxury goods firms will become bargains, and the euro will likely fall. Bond investors will likely rush to the few safe havens the euro-zone offers – Germany, the Netherlands and Ireland as well as assets in ‘old’ periphery countries like Norway and Switzerland. 

More broadly, a continued rise in French yields, in the face of policy inaction (a draft budget is to be presented to parliament at the end of September), will for the first time in over a decade sensitize international investors to the credit risk inherent in government balance sheets. What is intimidating is that here France is in good company, most of the major economies, China, Japan, the UK and the US are as indebted as it is. 

Is China OK?

China's economy grows at one of lowest rates in decades

For much of the last decade or so, Chinese friends and acquaintances, as well as many people I know in Singapore and Hong Kong, have remarked that their view of Europeans is a lazy and decadent people, too tolerant of the problems that beset their societies. This view is in part gentle mockery, and part sincere. Europeans, not used to being mocked, will look up from their Aperol spritz and ask what they are doing wrong?

Indeed, according to the latest (and fourth) University of Alberta ‘How China sees the World’ survey, it seems that most Chinese don’t rate the EU as a major geopolitical player, though a significant economic partner and more importantly, a tourism destination.

The survey highlights that the Chinese have a strong view of their country’s importance on the international stage, pitting it ahead of the USA in a bi-polar world order. The interesting elements in the survey are the casting of Russia as an indispensable, trusted partner on the international stage for China, and the confidence with which participants gauge a war with Japan as a likely geopolitical event.

To an extent, it is welcome to consider Chinese views on the rest of the world, granted the irony that for such an important economic and geopolitical player, there are relatively so few Western experts on China, and in Western public discourse there is not a well-developed conversation on Chinese culture and politics. Consider that there are very few Irish public figures who know China well, and the evolution of China’s economy does not get enough detailed attention in the Irish media, despite China’s enormous role in the world economy.

This might be because China makes it increasingly difficult for outsiders to understand it. In the past seven years, Western investment in China has dropped significantly, and the flow of Westerners to work in China has also fallen. A further illustration is that there are now fewer than 2000 Americans studying in China according to the Straits Times (down from 11,000 in 2019) while there are still some 250,000 Chinese studying in the US (down from 354,000 in 2019), and a further 150,000 Chinese studying in the UK (and close to 4,000 in Ireland).

The reduced social, political and commercial connection between China and the West makes it harder to read what is happening to the Chinese economy, with the additional concern that official Chinese data is not helpful either. Granted that China last week printed one of its lowest official GDP growth readings, this is a significant hurdle. Indeed, there is a sense amongst many Western economists that only an amalgam of very detailed, micro indicators (e.g. electricity usage) can help build a picture of what is really happening in the Chinese economy.

For example, In the USA, the Conference Board has reconstructed China’s economic data, and has concluded that not only has the performance of the Chinese economy overestimated, but it has been driven by the flow of huge amounts of capital into the economy that has steadily become less productive (in the sense that one dollar of capital leads to a decreasingly small return). It may be that the Conference Board team has gotten it wrong, but there is simply neither the forum nor the spirit for an open debate on Chinese data. Also, a prominent Chinese economist Gao Shanwen, who died of cancer last month, had stated publicly that the trend rate of growth in China is far lower than official figures suggest.

Despite that, the most interesting element is that the Chinese authorities have managed their economy better than most have thought, and to use a headline from the New York Times, China’s economy ‘has failed to fail’ in the sense that it has not had an obvious cyclical recession in decades.

If there is a strategy behind this, it looks from afar, as the state pushing activity from one economic engine to another. The Chinese property market has steadily deflated over the past six years, and the financial consequences of this have in my view not fully registered with banks and households. At the same time, through a mixture of state guidance and ruthless industrial competition, China has shifted the locus of activity to manufacturing (and the last Plenum, policy making forum, has ordained deep tech as the spearhead of the Chinese economic effort).

One consequence has been the creation of over-capacity, but in goods of sufficient quality and low production cost, that they displace European markets. Last week, exports of Chinese cars to Europe have just topped a monthly tally of 1 million, while European manufacturers (even Porsche) are struggling in China. The result is a crisis of confidence in German manufacturing, and a policy debate on how to curb the flow of Chinese exports into Europe.

In the past year, China has pursued an ‘involution’ policy, of reducing spare capacity across a range of industries, but this does not yet appear to have borne fruit and raises the risk that there is still a lot of operational leverage in the economy. Two other risks loom. One consequence of the funding of real estate and manufacturing through the banking sector is that in terms of assets, China’s banks are amongst the largest in the world, a systematic risk in the event of a downturn, and its public (including local and regional authority) debt, is dangerously high.

With trading partners, such as Germany, beginning to react to China’s export boom, the policy options for Beijing are increasingly limited as they try to maintain economic momentum. Another bad GDP print and investors will start to fear the worst.

Have a great week ahead, Mike

A Very British Coup

Ireland is known for its high-profile actors, from Liam Neeson to Cillian Murphy. But readers might also want to search out the work of actor Ray McAnally, one of Ireland’s best but slightly forgotten actors. Anyone curious to sample his talent should watch the 1992 thee part series ‘A Very British Coup’. It is based on the book of the same name by Chris Mullin, the former Labour MP, Birmingham Six campaigner, and someone who was regarded as one of the most likeable MPs in Westminster. His political diaries are also appreciated as the best in the genre.

‘A Very British Coup’ appeared around the same time as Michael Dobbs’ ‘House of Cards’, which is now famous in its American incarnation, though the British version is far better. In Mullins’ book, the central character is Harry Perkins, a newly elected left wing prime minister from Sheffield, and someone who wears his man of the people identity proudly. As soon as Perkins takes power, he runs up against the establishment, the press, the City, security services and the American government. Despite a valiant resistance, Perkins is eventually forced from power.

The book and tv series came to mind for two reasons, both of which concern next week’s Makerfield by-election on June 18, which could vault Manchester’s mayor Andy Burnham into Downing Street. The resignation of defence secretary John Healey last week ups the ante in this contest.

The first reason is that this manoeuvre is a particularly British one in terms of the logistics of the electoral process and consistent with the tendency in Westminster to discard prime ministers as if they are football managers. No wonder that some commentators refer to the Italianisation of British politics (in the 1990’s the average duration of an Italian government was one year, and we may now be on the brink of the seventh prime minister in ten years). To succeed, Burnham will need a comfortable victory in Makerfield, and a groundswell of support from Labour MP’s.

The second issue relates to the inbox of prospective prime minister Burnham. He is known to be far more political and personable than Starmer, and his mixture of ‘Irish blood and English heart’ (to quote Morrissey) will equip him for the challenges ahead.

Oddly, given the magnitude of change in the world order, some of the challenges that a possible prime minister Burnham will face, are like the ones that confronted Harry Perkins – a gloomy public mood and atmosphere of economic decline, trouble with the Americans and a pressing need to keep up with new technologies.

The special relationship between Washington and London is, like many other institutions of the post Bretton Woods era (NATO, the UN, World Trade Organisation), in real trouble. Senior American politicians like JD Vance and Elon Musk think little of inserting themselves into the debate on immigration and identity in the UK. The NHS is on the verge of cancelling a large contract with Palantir, and the White House has managed to push the UK back towards the EU politically. It has done much the same for Iceland, Norway, Ukraine, Hungary and even Canada.

Then, there is the gloom of the economy. In recent months a series of books has been published about the UK economy, the general tenor of which is captured by AG Hopkins’ ‘The Land Where Nothing Works’. There is a very clear, though frustratingly long-term (for politicians) policy recipe that might allow the UK to lift its sluggish trend growth rate. It involves an overhaul of the education system, far greater state funding of the universities, reform of the welfare state and labour market, and cultivation of broader private investment. Chatter on the left wing of the Labour party suggests that this may not be the chosen path of a Burnham cabinet.

The other related element is technology. In ‘A Very British Coup’, computers were edging into the mainstream, now robots, humanoids and AI are the mainstream. Thanks to the work of a few talented private sector entrepreneurs the UK last year launched its AI Opportunity Plan, which in my view is one of the most coherent strategies for the build-out of a national AI plan.

Last week, the Starmer government followed this with the AI Hardware Plan, which leans heavily on the development of British super computing and next generation semiconductor capabilities. In both cases, Britain has the talent, the vision, but lacks real capital (two months ago the capitalisation of the Taiwanese and South Korean stock markets passed out the FTSE 100), and very markedly, the execution from politicians is missing.

If Andy Burnham becomes prime minister this summer, the risk is that he stops at the political coup of winning power, like the six prime ministers who have preceded him. A real coup would be to restore confidence and momentum in the economy and make Britain a relevant power in the 21^st century.

Have a great week ahead, Mike

League of Nations, II

One implication of the recent surge in the price of semiconductor firms is that the stock markets of Taiwan and South Korea are now larger than that of the UK (which in 1900 made up 25% of the world stock market capitalization). It is expected that the two East Asian countries will soon have more billionaires than Britain, many of whom have apparently been scattered to the winds by the Labour government.

Though a country’s stock market is a highly imperfect indicator of a country’s economic standing, it does offer good clues as to evolving industrial structure. Bond yield and currencies help to complete the picture, and the runaway UK 10-year Gilt yield (now above 5%) doesn’t tell a happy story either. Then, on GDP, the country whose rise impresses me is Poland, which has not suffered a recession in the past thirty years (COVID excepted). Its GDP has increased sevenfold since 1990, and by 2030 it is expected to surpass the UK in terms of GDP (based on purchasing power parity). Remarkably, Poland is also shaping up to be a geopolitical power as well.

The loosening of the globalized world order, and the advent of many new risks and challenges – from the impact of AI on economies, to climate damage to war – has the potential to knock some nations back, and present opportunities to others.

As such, we can expect that the rise and fall of stock markets and economies tells us a lot about the rise and fall of nation states. In a world where the established world order is shattered (OPEC is the latest long running institution to fall apart), the rise and fall of countries is accelerating, and has become more vivid. In 2020, in the context of how different countries and states were responding to the COVID crisis, we wrote of the idea of the ‘League of Nations’, and have emphasized the theme ever since.

There are many existing league tables of country performance – happiest nation, most innovative country and most competitive, to name a few. Those league tables tend to be dominated by small, advanced economies. Regular readers will know that one of my favourite long run economic themes is the success of the small, advanced economy model, notably so for the way in which these nations can adapt to changes in the broader world. The UAE is a case in point.

In previous notes I have also made the parallel between football and politics, and this is still valid. A few weeks ago I mentioned that in the last ten years the UK has had more ministers for housing (a whopping 14) than Chelsea FC has had managers (12). Chelsea have recently parted with their latest manager Liam Rosenior, and it might well be that a cabinet reshuffle or change of prime minister leads to Matthew Pennycook moving on from his job as UK housing minister.

Like football, the manager of a country is important. For decades, Singapore and the Emirati states have made a virtue of strong, visionary leadership, Greece’s Kyriakos Mitsotakis and more recently Mark Carney in Canada are associated with turning their nations away from troubled waters.

In today’s League of Nations, the winning formula is changing, and shifting towards all things ‘sovereign’ and ‘atom-like’. For example, last week Canada announced the creation of a sovereign wealth fund to help the buildout of critical infrastructure, and it also laid claim to be the host of the new multilateral defence bank (Chris Collins and I wrote about this in a recent note for Barrons). Further, as I mentioned last week’s note (‘Mythical’), successful countries will need to cultivate their own AI stack, and the merger of Cohere and Aleph Alpha is a sign of things to come (their main shareholder is German but the firm will effectively be Canadian from now).

Then, with a step change in the industrial structure of the developed economies of the world underway, from services and ‘bits’ (software, crypto) to ‘atoms’ (energy, infrastructure, defence, AI and quantum), those countries with the universities, capital base and innovation ecosystems, will thrive. America is the standout example, but the Nordic countries and the economic zones that surround the Alps (particularly Switzerland) are good examples.

One consideration regarding the stature of nations is age and pedigree. One of the elements that makes small, advanced countries successful is that their laws, democracies and institutions have been in place for some time, and therefore offer clarity and consistency to businesses for example. At the same time, as economies get older they can become sclerotic, acquire layers of regulation and fail to engage in the creative destruction necessary to keep economic growth at healthy levels. Whilst this is simply an observation, I have a hunch that like aging athletes, older, large economies (US, Japan, UK, France) resort to a ‘boost’ in order to keep their economies going, which may explain why they are excessively indebted.

A final word in praise of older economies and societies, which relates to the cultures, behaviours and ‘family silver’ they accumulate over time. King Charles III’s various speeches in Washington last week demonstrated the value of heritage, and he might just have saved Britain from relegation to the lower leagues.

Have a great week ahead,

Mike

Battle for Budapest

In the days before what is now known as the Iran War, and amidst the horrific suppression of its citizens by the Iranian state, a Dutch diplomat, having arrived at Tehran airport, was stopped and asked to disclose the contents of his luggage. He refused, citing diplomatic immunity, and left Iran, leaving his luggage behind. A subsequent inspection of the luggage in the presence of another Dutch diplomat, allegedly revealed three Starlink modems and a number of satellite phones.

It is not at all clear whether the devices were for ‘personal use’ or for the benefit of Iranian dissidents, but the incident reminded me of the efforts of George Soros to export hundreds of photocopiers into communist Eastern Europe in the late 1980’s and early 1990’s, so that dissident texts could be copied and circulated.

This was the very tip of the iceberg of Soros’ funding of the pro-democracy movement in Eastern Europe, and at one point it was said that he gave more in aid than all the Western governments together. In particular Soros, who studied under the philosopher Karl Popper (author of ‘The Open Society and its Enemies’), was committed to creating an ‘open society’ in Hungary, the country of his birth, and established the Central European University (CEU) in Budapest in 1991.

Around the mid 1990’s I recall Bill Newton-Smith, a philosopher and Fellow at Balliol College and associate of Soros leaving England to help run the CEU. As he left Oxford, a young student activist called Viktor Orbán had come the other way (in 1990 I think), to begin a research fellowship on the topic of civil society in Europe, sponsored by the Soros Foundation.

Orbán didn’t last long at Oxford, returned home to become a member of parliament and the leader of the main liberal party Fidesz. Orbán has been a central figure in Hungarian politics since then, but in the late 2000’s, underwent a political and moral transformation. At a conference in Prague some years ago, I spoke with a few entrepreneurs who had been early associates of Orbán’s, and who had suspicions as to the motivation behind his change of tack.

This change pivoted on his relationship with Soros, who Orbán has transformed into a figure of hate for the far-right internationally. Equally, Orbán flipped his view on Russia. He had been highly critical of Russia’s 2008 invasion of Georgia, but soon after, following a visit to St Petersburg to meet Vladimir Putin, Orbán started to change his stance on Russia.

For much of the past sixteen years, Orbán has commanded a large amount of popular support, though his actions and attitude in going against the grain of the EU have cost Hungary – in the last fifteen years, Hungarian GDP growth has lagged that of Poland by 0.8% per annum, tens of billions in EU aid has been withheld, and corruption has become institutionalised under Orbán. Budapest has become a staging post for the Russian security services and teachers, women, judges, amongst others have suffered in ways they would not expect in a normal European country.

In this context, the general election in Hungary (April 12^th) could become a critical turning point, and is highly important for the EU. At a broad level, polls point to a victory for Peter Magyar of the Tisza Party, with the majority of the opposition parties in Hungarian politics having swung behind him. However, in the context of extensive gerrymandering, a propensity for ethnic voting groups (Hungarians living abroad and Roma in Hungary) to tilt toward Orbán, and the capture of state institutions and budgets, the outcome is highly uncertain.

Not only is Orbán an ally of Moscow (Orban’s team has been accused of leaking confidential EU discussions to Russian officials, and Orbán holds frequent meetings with the Russian foreign minister), but he has become the darling of the international MAGA movement. Orbán’s campaign been endorsed by Benjamin Netanyahu and Donald Trump, Marco Rubio visited Budapest in mid-February and vice president JD Vance will travel there on April 7^th, just before the election.

There are already allegations of impropriety and vote rigging against Orbán, in what will be a hotly contested election, and deep suspicion of social media influence by Russia, not to mention the support of the White House.

EU leaders fear a close election or that Orbán, having lost the vote, will use his remaining days to change laws and appointments to key institutions. The example of Poland is being mentioned, where on taking power Donald Tusk faced years of difficulty in removing hard-right opponents from media and other institutions.

As such, the EU will have to invest enormous time, energy and capital in remaking Hungary. The short-term gain for the EU will be the absence of the Hungarian veto on European foreign policy stances, notably so in the case of Ukraine.

Should Orbán win, or continue to contest a close vote, a more existential issue faces the EU that will centre around a gathering debate on how to further sanction and potentially expel an EU member that is steadfastly recalcitrant.

Lurking behind the election, is a deeper foreign policy issue for Europe, in the context of several major wars and the disintegration of NATO, the need to combat more fiercely interference in the democratic processes of EU member states.

Have a great week ahead,

Mike

Old Money

A recent book, Samuel Moyn’s ‘Gerontocracy in America, highlights the growing concentration of wealth and power in the much older generations in the US, whilst younger generations face historically high valuations in real estate and financial assets, and how this growing intergenerational divide might be mended. Moyn, in my view, has struck a chord that will become one of the new dividing lines in politics, in Asia and the West.

His book brings demographic change into focus, a slow-creeping risk to economies, society and public life, but whose implications are only just surfacing in the public debate. Despite that, from a popular point of view, the sense in many Western countries is that there are too many people, or rather that infrastructure has not kept up pace with population growth – I am writing this in Dublin, which is an excellent case in point.

Yet, the long-run demographic trends – falling fertility, longer life expectancy and a shift in population composition towards a much smaller working (tax paying) population, will have enormous impacts on society, pension systems and debt loads, to name a few economic issues.

As much was evident in Germany’s recent pension reform debate which was nearly upended by Helmut Kohl’s grandson Johannes Volkmann and a group of other young parliamentarians who voiced the right of the younger generation to not have to shoulder the financial burden of their parents’ generation (under the German system, and many others, the working population effectively funds the retirement system of the older generation)..

The best starting point on the outlook for demographics is the United Nations World Population Prospects website. and the data – especially in chart form – are quite striking.

The UN data show that as we approach 2100 the world population will plateau and start to shrink. From roughly 2080 onwards the world population growth rate will turn negative for the first time in centuries (wars apart), as the death rate passes out the birth rate. Within the age cohorts, the over 65 group will expand by a billion people in the next thirty years.

More specifically, at the country level, the US death rate will surpass the birth rate in around 2040, and population growth is likely to only be sustained by immigration. The picture is worse for some European countries – Italy for example is already in negative population growth territory, and the most negative forecast scenario from the UN has the Italian population dropping from over 60 million today to 25 million by 2100 (the same level as when Garibaldi unified the country).

Equally, China, which has been renowned for its economic and population growth, will endure a collapse in the 24–65-year age group, who today number 830 million people and by 2100 are expected to comprise 280 million people. China is projected to be the country most affected by ageing, with its, China’s elderly dependency ratio is projected to surpass 100% by 2080, meaning there will be more people aged over 65 than those aged 15 to 65.

The expected collapse in the working population begs serious questions for the economy – who will pay taxes, sustain pension systems and where will demand for financial assets come from. Markets are not worried, yet.

In general, researchers find that there is a positive link between demographics and asset prices, a finding that is predicated on the rise of the boomer middle class and the coincident equity bull market and fall in bond yields. The idea is that until they retire, working households invest more in real estate, equities and other riskier assets, but then shift to income-oriented assets like bonds as they get older and require income from investments. The oddity in that respect is that despite an ageing population, equities and real estate are very expensive. This may well owe to a growing investment culture, a record level of wealth (USD 500 trillion worldwide) and the prosperity boon that has resulted from globalization.

In this context, old money will become a political target, both in terms of demands for lower inheritance taxes, to more populist measures to tax the ‘old’ and give the ‘young’. For governments who worry about demand for their bonds, wealthier older citizens might make ideal candidates for financial repression (their children would face lower inheritance tax provided that capital spent a period of ‘purgatory’ invested in government bonds – I outlined a similar theme in ‘Patriotic Capita l’)

At the same time, pension systems will have to change to accommodate a proportionately smaller number of workers (to pensioners). Private pension systems will become more common, they will invest more, earlier, with a tilt to riskier assets.

Concurrently, I expect to hear more on the need for states to establish sovereign wealth like funds (based potentially on the sale of state assets) to help provide for future pension liabilities. Another concern will be the need for states to cushion the potential blow of AI on workforces (a fund that holds equity in AI firms might be an avenue), at least through a transition period. In the long term, AI and robotics may well allow more older people to work for longer and for more women to enter the workforce. And, I haven’t managed to tackle the topic of later retirement ages and how that will impact the workforce and society.

The effects of demographics are not yet showing up in markets, and are just creeping into the investment industry, but it will become a major fiscal and financial megatrend.

Have a great week ahead, Mike