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

Russian Risks Rising

Things must be pretty bad in Russia because a few weeks ago I had an invitation to speak at the St Petersburg Economic Forum. As much as St Petersburg is one of my favourite cities, I will not be going. But, my disdain for Russian politics is almost matched by a curiosity for what is happening to the Russian economy and society.

In the past two months there have been many reports on the emerging weakness in the Russian economy, minor spats of dissent in Russian and the toll that the war is having on demographics – M16 recently released an estimate of over 500,000 deaths of Russian soldiers in the war on Ukraine so far (for context Russia suffered 450,000 deaths from combat/starvation/disease in the Crimean War and 15,000 in the 1980’s Afghan campaign), with a monthly casualty rate approaching 35,000.

As a result, the unemployment rate is close to 2%, labour shortages prevail and the growth of the economy is stalling out. Russia’s economy is now largely a war economy, defence spending is 8% of GDP but many private and state resources have effectively been co-opted to bolster the war effort. Cracks are starting to show. The budget deficit is widening despite high oil prices, shortages of goods are more noticeable I am told, and banking and taxi apps frequently don’t function.

While there are some reports of dissent amongst the Moscow elite, broad discontent is not visible, and nor should people expect to this this until things turn very bad. One memory I have is on morning runs through Moscow, passing the heaped flowers marking the spot where Boris Nemtsov, a Moscow insider but Putin rival, had been gunned down on the bridge that passes the Kremlin in a not too subtle message to anyone who thinks Vladimir Putin is not the only solution to Russia’s problems.

Putin’s predatory style is also evident across Europe in act of political manipulation (e.g. Nathan Gill the former leader of the Reform party in Wales was sentenced to 10 years in prison for taking bribes to make pro-Russia statements), sabotage and grey-zone hostile actions which we have written about in previous notes (‘Shadow Wars’ and ‘From Great War to Total War’). Europe is slowly adapting to this and there is less naivety and tolerance for Russia’s actions, amidst warnings from intelligence services of a potential conflict with Russia in the next three years.

The very striking development is how Russia’s attack on Ukraine has changed the strategic landscape around Russia. Previously neutral states, Finland and Sweden, have joined NATO and there is now a rush to increase defence spending and capabilities across the Nordic and Baltic states, not to mention Poland. Hungarians voted to jettison Viktor Orban, a friend of the Kremlin, and Hungary’s new prime minister is restoring its place as a country that other EU members can have faith in, and notably repairing relations with Ukraine. Ukraine and Moldova are now on the (slow) path to join the EU, and within the Union, defence spending, manufacturing and innovation are picking up.

It is also worth noting that Russia’s relationship with China is changing, with Moscow now very much the weaker party, and increasingly beholden to Beijing. It might well be that China is the actor to bring forward a solution to the war in Ukraine, and thereby extricate Russia from its bloody, strategic mistake.

While there is no sign yet of an economic tipping point in Russia, nor more so of a political one, the sense is that the strain is mounting, and the odds of a ‘Russia’ crisis are slowly rising. This might manifest itself within Russia, or its security state, or could express itself in a tail-risk attack on a European country. Drone incursions into Lithuania and Romania have already heightened tensions.

In terms of the Russian economy, I recall, as a young economist, attending a faculty seminar with Stanley Fischer in 1999, when (as one of the IMF chiefs) he described the urgency behind the IMF bailout of Russia, which was partly motivated by risks posed by Russia’s nuclear arsenal and the need for stability. Stability took some time to arrive and when it did, came in the form of Vladimir Putin (Catherine Belton’s book ‘Putin’s People’ is very good here).

Compared to 1998, the Russian economy is structurally much changed, but vastly behind the potential levels it might have reached. Remarkably, it is a competitive laggard in key hard technologies from semiconductors to AI, and less so in quantum computing. To that extent Putin has robbed his country of an economic future, and the consequences of his war are rising.

As I write the Ukrainian army has marked the beginning of the St Petersburg Forum with drone strikes on the city.

Have a great week ahead, Mike

Lost at Sea

As a child I was fascinated and terrified by tales of the Bermuda Triangle, an area between Florida, Puerto Rico and Bermuda where ships and planes disappeared without warning, allegedly. Legend had it that a mysterious magnetic field around the Sargasso Sea drew vessels to perdition, or that even darker forces were behind the disappearance of the crew of the Mary Celeste.

Without stretching the analogy too far, my feeling is that financial markets have entered a logical Bermuda Triangle, or even Trilemma. Data, models, rules and indicators go in, but come out logically impaired. In particular, there is an unreal sense from at least three asset classes that are at historically extreme levels, each apparently contradicting the other. They cannot all be right.

In one corner, the US has, for the first time since 2007, issued long-term debt (30 years maturity) at a yield of 5%. Then, US stock market valuations are at an all-time high since 1929 and, as we stressed in last week’s note, semiconductor stocks are in a speculative frenzy. In another corner of the triangle, oil prices are pushing the highs of the last two decades.

This trio of market signals leaves investing logic in a grey zone — a Bermuda Triangle-like make-believe world. This stretched logic suggests that the prosperity and productivity of AI-related capital expenditure will rescue the world from both high inflation and a debt crisis, and will also prove powerful enough to compensate for the effects of a momentary energy crisis. I am not sure.

The confluence of these three indicators is interesting because each one points to a long-term trend that investors and policymakers cannot ignore, but equally, each one rests on a short-run vulnerability.

Rising bond yields in Europe, the UK, Japan and the US are an early warning of a debt crisis, or debt purgatory, to come. In the very short term, they signal that inflation is creeping higher whilst a number of policymakers — notably on the Fed’s FOMC — appear complacent about this development.

Equities are trading at record high levels and valuations, mostly because earnings and business cycles are strong. But a very small number of stocks has pushed the market higher, caused in part by the fact that sectors like semiconductors are heavily financialised. What I mean by this is that the deployment of exchange-traded funds and options has surcharged the prices of semiconductor stocks, and likely driven them well above long-term fundamental valuations.

In my view, Intel’s ability to treble in value since the end of March (from USD 41 to USD 129 last week) has less to do with the fundamentals of the company, and more to do with speculation. In support of this, a recent Goldman Sachs note shows that retail investors now account for around 20% of US stock market trading.

Energy prices remind us that in a multipolar world, commodities — or rather their supply and refinement — acquire a premium, and that a number of countries will have to address shortcomings in industrial supply chains. For example, last week Willie Walsh, the former airline chief executive, warned that the UK has scant jet fuel refining capacity. As such, energy infrastructure will be an area for future investment.

In the short term, however, supply pressure may be more acute: oil inventories are being drawn sharply lower. Unless there is a full and speedy resolution to the Iran War, estimates from JP Morgan point to world oil inventories dropping to 6.8 billion barrels by September — just enough to keep refineries operating worldwide.

So, like the Sargasso Sea, market compasses are spinning in different directions, and it is difficult to discern a clear narrative. The confusion arises from the changing geopolitical nature of the world, the fast shift in industrial structure away from ‘bits’ and towards ‘atoms’, shortages of refined oil and compute, and the intense financialisation of specialised sub-industries such as semiconductors and commodities.

Given the disagreement between markets, the obvious question is: which one is right? A ‘two-handed’ economist might argue that the stock, commodity and bond markets are all correct, but on different time frames.

In my experience, the bond market is the most consequential, because when it worries, it imposes a cost on other markets and on political actors. The overused but apt quote from President Clinton’s adviser James Carville in the mid-1990s captures it well: “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

So, the ‘market triangle’ or trilemma is resolved by bonds showing their displeasure at high oil and inflation, slowing the economy and walloping the over-bought sections of the stock market.

From a policy angle, bond markets are highlighting the urgent need for policymakers to calm inflation — through rate rises from central banks, and an early test for incoming Fed Chair Kevin Warsh — for governments to reduce debt, and for greater policy clarity in countries like the UK. The silver lining is that credit markets are so far well behaved, signalling that the healthy business cycle should allow for these policy actions to be made now, before it is too late.

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

La Conquête

A few years ago I was walking through the Gare de Lyon in Paris when I was brought to a halt by the sight of an elegant woman strolling through the concourse. She was followed by a black Labrador, a porter, and then a smaller gentleman trundling behind. The lady in question was actress Julie Gayet, wife of Francois Hollande, the former President of France (the gentleman). One of Hollande’s most famous acts as President was to sneak out of the Elysee on a scooter for what the British tabloid press might call ‘trysts’ with Julie.

A distinguishing factor of French politics compared to Anglophone countries like the UK, Australia and Ireland (it used also be the case in the US) is that a politician’s private life is private, and not for public consumption.

In keeping with this spirit, in 1899, President Félix Faure allegedly died in the arms of his mistress. More recently, presidents like Giscard and Jacques Chirac married well, but had plenty of ‘adventures’. Indeed, the film about Bernadette Chirac ‘Bernadette’, starring Catherine Deneuve is quite good in this regard. Speaking of which, another film to recommend is ‘La Conquete’, the story of the disintegration of Nicolas Sarkozy’s first marriage whilst he rose to power. Sarkozy has done more than most to banalise French politics, but his relationship with Carla Bruni has also introduced a popular sense of glamour into public life.

My reflections on the love lives of French presidents are motivated by two things. Francois Hollande has this week declared himself ‘ready’ to enter the battle for the 2027 presidency. With much attention on the right, there is space on the left of French politics for a serious candidate, and Hollande sees an opportunity, though he may well be beaten to it by Dominique de Villepin (famous foreign minister and then prime minister under Chirac who led France’s policy on the 2003 war – there is a good film on this ‘Quai d’Orsay, starring Julie Gayet).

The other event was the ‘coming out’ of Jordan Bardella and Maria Carolina de Bourbon des Deux-Siciles as a public couple, thanks to Paris-Match. In the likely event that Marine Le Pen cannot contest the 2027 presidency, Bardella will be the Rassemblement’s candidate, and according to polls the frontrunner in the contest.

If elected, he will have little in common with previous presidents, apart from the fact that he is male. He is different in a few respects.

The first is that he is a manufactured candidate, in the sense that from a very early age he has been groomed and cultivated by the Le Pen clan, provided with speaking coaches and marketing strategists. To that end, many suspect that the ParisMatch report is just another marketing stunt to burnish his profile, it appears too sterile and planned, and there is nothing worse than a French politician who is not genuinely passionate.

The second more serious accusation is that Bardella has done little of consequence in his professional life and is effectively untested as a leader and driver of policy. In this regard, he has more in common with other young politicians across Europe, whose only claim to credibility is their addiction to TikTok posts. To date many of his public appearances are carefully choreographed, but in the long run into an electoral campaign, Bardella will have to think and speak on his feet, which may be his key weakness.

A related, and underestimated criticism is that Bardella has not demonstrated his intellect, and has not passed through France’s Grandes Écoles – as have the likes of Hollande, Edouard Philippe, Macron and Chirac, who apparently topped his class. This rite of passage is important in the context of the way the French state operates – it is a pyramidical elite, made up of generally very capable people, who act and think alike. In order to make this system work, the person at the top needs to think like, and have the intellectual respect of those below.

Under that scenario, a young, inexperienced Bardella, without the crutch of an experienced policy team, would struggle, and it is becoming clear that the French establishment is girding itself for a Bardella presidency by placing centrist type policymakers in key institutional posts.

There is a scenario where, if he was victorious, the establishment might hand him two poisoned chalices, a crisis over immigration and potentially, a financial crisis. France is in my view the most financially vulnerable country in Europe, given the state of its finances and the fact that parliament has done nothing to resolve this. In that regard, a Bardella presidency could trigger financial chaos in France, that might eventually force reform of pensions and social security (Bardella would be a lame duck by then).

Thus, Bardella does not fit the profile of the typical French president, and as the presidential contest gathers steam his limitations may become more obvious. According to polls, the one centrist politician who can come close to beating him is Édouard Philippe, former prime minister and author of the excellent ‘Dans L’Ombre’. If anything he needs to learn from this work of political fiction, and go a little ‘MAGA’.

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

Mars, Venus or just lost in space?

Two recent events have me thinking of a 2003 book by the international relations expert Robert Kagan, entitled ‘Of Paradise and Power: America and Europe in the New World Order’, which started life as a 2002 article in Policy Review. In the foreign affairs world, the book is known colloquially as ‘Mars or Venus’, because the opening sentence goes ‘Americans are from Mars and Europeans are from Venus’.

Kagan’s aim was to explain that Europe and the US had very different views of the world, and that these differences were rooted in culture, history and aims. Europe is the older, wiser and more genteel continent, concerned with roping its social democracy in well made rules, whereas the relatively younger American republic (250 years old this year) was more muscular, in military and financial terms. Kagan’s book, in keeping with the reception given to Francis Fukuyama’s ‘The End of History’ and more recently Graham Allison’s ‘Destined For War’, is better known for its strapline than the detail of its argument, but then again that is the art of the successful author, and one that in comparison, few European international relations experts have cracked.

That, in 2002, Kagan felt the need to state that Europeans and Americans are different, betrayed the long-held sense that they are the same people, in the sense that in 2002, the vast majority of Americans could trace their family history back to Germany, Ireland, Britain and France (in 1960 some 85% of foreign-born Americans were from Europe in vs 10% today).

That much was also clear during the many events in Washington to mark St Patrick’s Day. President Trump invoked his own European heritage (Scottish mother, German father), teased Speaker Mike Johnson as to whether he was a WASP or Italian, whilst Taoiseach Micheal Martin told how a Cork man, Stephen Moylan, a senior officer in George Washington’s staff, is credited with the first use of the phrase ‘the United States of America’ in 1776.

In that context, the ‘Mars and Venus’ argument is ever more relevant today as the divide between Europe and its American cousins widens. While European countries wholeheartedly supported the US in the 1991 Kuwait War (see our recent note) and in the aftermath of 9/11, the doubts that many European governments had over the 2003 invasion of Iraq partly motivated Kagan’s book (the film ‘Quai D’Orsay is very good in this context).

In that context, the polite refusal of nearly all of America’s allies, not just in Europe but also the likes of Japan and India, to send ships to the Strait of Hormuz, is emblematic of a deepening divide, and in recent weeks a good number of American friends have reached out to ask ‘is it us, or is it you?’. My polite response is that ‘it’s the White House’ (noting that most Americans are against this war), but more broadly I feel that one of the great anomalies of our time is that so few Americans realise the damage that is being done to America’s reputation abroad.

So, one might argue that Kagan’s ‘Mars-Venus’ short-hand for international relations has never been more true, and the fact that Europe has done little in the past twenty years to bolster its security, and to deepen its financial markets, gives some weight to American frustration and derision. Equally, the vandalization of shared values (democracy) and institutions (NATO, the United Nations) by the White House causes horror across European capitals.

Yet, at this painful point in trans-Atlantic relations, I wonder if we have reached peak ‘Mars-Venus’, in the context that Europe today is still quite like it was in 2003 in terms of world view, whereas the US is politically and socially very different to that of 2003.

My reasoning is that Europe is finally having the ‘neo-con’ moment that the US went through in the early 2000’s (Robert Kagan was part of that movement), and is starting to rebuild its defences, though it lags badly on capital markets union (now Investment Savings Union).

Oddly, Europe no longer shares the same enemies as the US. Russia should be the prime concern of European security chiefs. It is also troubling that the Trump administration actively supports far-right parties like the AfD in Germany, and the few European nations who side with the Kremlin (VP Vance visits Hungary next week).

As such, Europe’s path and challenge is clear – to remain the sole liberal democratic pole in a disordered world. When Robert Kagan wrote his book in 2003, the natural assumption was that American democracy was a beacon for others to follow, as far as Asia and even across Eastern Europe (Kagan’s wife Victoria Nuland was a senior American diplomat serving in Eastern Europe during ‘the Maidan’ in 2014, where her most famous utterance was ‘f@#k the EU’).

Yet, America’s democracy is now in deep trouble, and one of the sharpest critics of Donald Trump’s approach is Robert Kagan, who warns of the descent towards a dictatorship.

It will be over by Christmas

Mon centre cède, ma droite recule, situation excellente, j’attaque

At the First Battle of the Marne, not so far from Paris, in September 1914, Marshall Foch sent the above, inspiring communiqué to Marshall Joffre (‘my centre is crumbling, my right is retreating, the situation is excellent, I attack!’). The Battle of the Marne was arguably the greatest land battle of the twentieth century and caused over 500,000 casualties. Its strategic effect was to halt and reverse Germany’s lightning attack across France towards Paris and set the scene for years of entrenched warfare. At the time, the Great War was some three months old, and many thought that ‘it will be over by Christmas’.

There are few parallels between the First World War and the Iran War, but there is a creeping feeling that, in the absence of a clear strategy from the White House (see last week’s note ‘Safe Places’), there is a risk that this conflict becomes entrenched.

It is already very costly. In the first week of the attack on Iran, the US apparently spent close to USD 11bn on weapons and munitions, and that is without calculating the human and economic costs. In the context of record public indebtedness, the question is not so much can America win the war, but can it afford it?

Indeed, it seems largely forgotten now that America’s own wars have been associated with indebtedness. That the American Revolutionary War was financed mostly by the French (Lafayette and Beaumarchais), Spain and the Netherlands – indeed in a lesson for policy makers today, Congress had to print money to pay off these loans, which had the effect of causing rampant inflation and devaluing the dollar. It’s also worth flagging that the American Civil War saw a sharp run up in debt (US sovereign debt in 1865 was 40 times what it was in 1860, according to figures from the Treasury), the consequence of which was a collapse in the dollar, again.

Still, the lesson that wars generally strain finances, seems to have been habitually forgotten. Some might recall that Larry Lindsey, an economic adviser to George W Bush’s administration left his job after producing what at the time was considered to be a high estimate (USD 200bn) of the costs of the second Iraq War. It turned out to be a conservative estimate, as the Congressional Budget Office put the cost of the war at USD 2.4bn and other analysts have put the total cost at closer to USD 5bn.

Equally, Britain and France are fascinating in many ways – they have very old and rich economies and together have been involved in most wars going back to at least 1000 AD. Britain is a nose ahead of France in that there is arguably a longer thread of data available about its economy, and it is very well curated by the likes of the Bank of England and the Office for Budget Responsibility, whose note on ‘300 years of public finance data’ is a must read for aficionados of economic history.

If I could sum up those 300 years of data it would be to state that wars drive indebtedness, and then indebtedness itself drives fiscal reform. Between 1700 and 1800, debt to GDP in Britain rose from 25% to close to 200%, during a period that was marked by wars over the Spanish Succession, the Austrian Succession, the Seven Years War, the American War of Independence and of course the Napoleonic Wars (after the French Revolution). As a rough rule, British participation in the many and varied wars of the 18^th century led to spikes in defence spending of up to 10%, whilst the more deadly world wars saw defence spending push beyond 50% (of GDP).

More broadly, the Kiel Institute has created a database of conflicts going back over the past 150 years that measures the economic costs of war and they have used this to create a model that scopes the potential economic costs of war scenarios. Though quite chilling in its consequences, their interactive tool is useful, and I recommend it to the White House.

For example, I input a scenario (based on 2023 economic valuations) for a war that takes place in Taiwan and also in China (assuming a dramatic US riposte). The direct economic and capital damages are well into the USD 20 trillion, and that is without counting US military losses and the disruptive effect on world trade, risk appetite, and financial market collateral damage.

So, not only do armies march on their stomachs as Napoleon hinted, but also on their balance sheets. In this alarming context, geopolitical ‘players’ have two pressing needs. One is to build out their military capabilities, and the other is to reduce debt – in part to allow them the fiscal space to be warlike. With the US now spending over USD 100 bn more on interest payments on its debt than on its military, it is living a strategic contradiction.

Have a great week ahead, Mike

Safe Places

I started the week in the beautiful surroundings of Killarney, Co. Kerry, where after nearly two months of constant rain, blue skies opened up. One of my earliest memories of Killarney, thanks to Irish-German cousins, was the sizeable German community there (Killarney used have a German butchers) and a commonplace saying at the time was that the reason many Dutch and Germans were drawn to the southwest of Ireland is that its remoteness and prevailing winds, meant that it would be the safest place in Europe in the event of a Cold War nuclear exchange.

That much was mildly reassuring given the news from the Middle East.

More so in the context that, in the same corner of the world at Île Longue in Brittany, Emmanuel Macron announced an upgrade of France’s nuclear deterrent, and critically the building of a European nuclear umbrella encompassing the likes of Greece, Belgium, Poland, Germany, the Netherlands and Sweden. This was followed by bi-lateral announcements by other states, notably Germany, and work on joint operations committees will start to take shape from the end of this year.

This is a major announcement from France and the involvement of other countries is highly significant, especially in the case of Germany, and it is yet another indication of the advent of a Military Union in the EU (and I would include Norway and the UK here, possibly Canada). Yet, as we noted in last week’s note (‘Riddle of the Funds’), capital markets union, and business scaling incentives will be more important than nuclear missiles in enabling Europe to build a military innovation complex.

My worry is that with the pace of geopolitical events taking place at a rapid speed, Europe may leave it too late. The attack on Iran was a case in point, but the White House has left the outside world convinced that it has no coherent strategy for Iran, and this exposes multiple risk scenarios.

Five weeks ago in our ‘Persepolis 2’ note, we concluded by observing that the future of Iran might change when ‘An opening may come when the Supreme Leader, Khamenei dies – he is 86 and suffers from cancer. This event could provide the cover for a discrete but meaningful shift in policy, and the start of negotiations on sanctions and Iran’s nuclear program, and the beginning of a more promising era’.

Broadly, my view has not changed. The volatility of the past week has taught us much more about the behaviour of investors and market analysts, than the future of Iran. There has simply been too much ‘knee-jerkism’, about the impact of the closure of the Strait of Hormuz on long-term inflation and bond markets for example.

What matters most is the long-term alignment of Iran with other countries in the region, post this war, and in this context, there are several considerations. If this war ends in a ‘Mission Accomplished’ style declaration of triumph by both the US and Iran, the first factor will be the extent to which Iranian civil society has any role in the government. Iran is unlike Iraq was in 2003 in that it has a broad middle class, and a large, wealthy diaspora ready to contribute to the country. Unfortunately, it is also unlike Iraq in the sense that it has a highly entrenched regime elite, and herein lies the fallacy of the White House’s decapitation strategy. The Iranian ‘regime’ is composed of priests, oligarchs and the military, who have deep economic interests across the country (the IRGC own stakes in many businesses) and unrooting them will be difficult. If somehow, a more modern elite was to eventually come to power in Iran, then this would be a considerable boost for my ‘Fourth Pole’ thesis of a coherent, thriving economic zones across the region.

If Iran is not ‘Iraq in 2003’, then the prosecution of this war by the US looks from a political point of view, nothing like the 1991 Gulf War. At the time George H. Bush, himself a decorated aviator, spent time building a coalition of allies to fight a war with a very clear and limited objective. Bush, General Norman Schwarzkopf and Colin Powell were recognized for their leadership and clarity, and we cannot say the same for Secretary of War Hegseth. Today, there is no sense of an overall strategy (though Israel’s aims are clear), and the enduring sense is that the White House is now a source of uncertainty, rather than an architect of peace. The reluctance of European nations to participate reflects this, and the damage that Trump has done to the trans-Atlantic partnership.

Then, finally, the remarkable feature of this war is how publicly quiet Russia and China have been about the plight of their Shanghai Cooperation Organisation (SCO) partner. China has become a vital financial partner in the last decade, Russia is at the epicentre of Iran’s economy and military supply chain. I recall taking an internal flight in Iran twenty years ago where the bodyguards of a Russian businessman stood protectively in the aisle for the duration of the flight (including takeoff and landing).

The danger is less Russian opportunism, but rather that it and China perceive America’s action to be strategic, and that they respond in kind. Other countries like Turkey will also ponder the post-war landscape and what it means for their regional positioning.

Let’s hope that none of them think of Kerry!

Have a great week ahead, Mike

Riddle of the Funds

A friend who lives in an isolated area and therefore in need of good reading material, recently asked me to recommend some geopolitical oriented thrillers. I immediately thought of decent, new writers in the field like David McCloskey and Charles Beaumont, the interesting recent James Stavridis/Eliot Ackerman books that straddle fact and fiction, as well as the scary ‘If Russia Wins’ by Carlo Masala.

However, many of my favourites are from different eras, Laurence Durrell’s ‘White Eagles over Serbia’ set during the Cold War, and then in a bygone period of great power competition, the works of Eric Ambler and of course, Erskine Childers (‘Riddle of the Sands’ ).

The end of globalization and the onset of great power competition means that those works remain relevant though, if on the fourth anniversary of the war on Ukraine European policymakers wanted reading recommendations, I might well propose a book like Sebastian Mallaby’s ‘The Power Law’, or Azeem Azhar’s ‘Exponential’, and to be cheeky, even ‘The Art of the Deal’.

My reasoning, with Europe (the EU, UK, Nordic nations) finally starting to mobilise its factories and innovators to bolster its war economy, is that there remain several missing elements in the quest to build the industrial champions of the European war economy. Europe’s politicians are very good at high minded rhetoric (there are repeated calls to build the European Google, Palantir and Anduril), and even better at racking up debt, but less gifted at spurring large scale innovation.

For instance, the response to the hostile American message to the EU at the 2025 Munich Security Conference was the lifting of the German debt brake, while the recent threat to ‘take’ Greenland has prompted multiple calls for the issue of ‘euro-bonds’.

However, with German military spending and defence related industrial production now taking off, the secret to defence and security innovation lies more in business school texts, than in war college. There are a few elements to highlight here.

The first one touches on a perennial problem for Europe, the lack of depth in financial markets. Amidst an epidemic of defence start-ups and fund launches across Europe, there are still relatively few investment funds focused on the kind of later stage investing required to scale security focused companies to a size where they can become part of the growing industrial infrastructure in Europe. This lacuna owes in part to the failure of Capital Markets Union (now Investment Savings Union), such that few pension funds and institutional managers are investors in ‘strategic autonomy’.

It also reflects a labour market problem – there are simply few investors in Europe who have good knowledge of the defence and dual use ecosystem.

The idea of an ecosystem is the second aspect of the defence investment riddle. A small number of countries have cracked this – the US and France stand out. In the US, like France, the education system provides a rich supply of engineers and technologically capable graduates (e.g. Onera Labs in France), many of whom have a layer of business school training, and in a good number of cases have ties to or experience in the military.

Ecosystems encompass large firms, divisions of the military and defence establishment (i.e. SpaceForce), as well as sector specialist investors. When the elements of such an ecosystem are connected and work together, they can propel an interesting start-up to a viable enterprise in a few years. A developed pan-European ecosystem does not exist, and its cultivation needs to surmount cultural obstacles (as the recent Future Combat Air System (FCAS) debacle has shown), tax and incentive policy, and a more open approach to innovation from large European firms.

Then, the element that is to my observation missing in many new defence focused start-ups and first-time investment funds is the presence of seasoned business operators who have experience in scaling businesses and advising on how best to navigate the various complex government procurement pathways across Europe.

This is a critical omission in the defence sector because government led procurement can help start-ups survive, but not necessarily grow. This is doubly so in dual-use technologies such as cyber security and hardware (including new materials), where ‘go to market’ is a more important imperative than ‘go to war’. Compared to the US, Europe has a short supply of such operators, and in general governments have not done a good job of encouraging them to become part of the ‘strategic autonomy’ economy.

Europe faces a diplomatic disengagement by the US, a grave security threat from Russia and industrial dislocation by China. As such, Europe’s war economy needs to add up to much more than guns and drones, but must rest on innovation, entrepreneurship and ambitious capital.

Have a great week ahead, Mike