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

You’re in the army now

At a recent dinner event three people, myself included, referenced Valery Gerasimov, chief of the general staff of the Russian army, and famous in geopolitical circles for a 2013 essay where he outlined the concept of ‘total war’ as seen through Russian eyes. It is a view of conflict that covers many strategies such as cyber, border testing, propaganda, intensive social media and covert attacks, for example. This approach has been very much on display across Eastern Europe and the Baltics – the encouragement of discord in Bosnia, the hollowing out of Hungarian politics and in particular the harnessing of Belarus as a form of geopolitical attack dog. Indeed, the fact that General Gerasimov has entered our minds is a sign that the doctrine is succeeding.

An excellent steer as to the tactics of ‘total war’ is David Kilcullen’s book ‘The Dragons and Snakes’ where he examines the new, unconventional forms of conflict pursued by the likes of Russia and China. One striking example Kilcullen describes is Russia’s efforts to drive immigrants and asylum seekers through the border with Norway, the aim being to test Norway’s reaction, its border security and to generally aggravate NATO.

Total war is highly effective. The ongoing destabilisation of adversaries through unconventional means is relatively cheap and effective, especially so when many governments in the West refuse to publicly acknowledge the manipulation of the infrastructure of democracy and public life. Other efforts, such as assassinations and the incursion of drones and jets into European airspace, with the added spice of cyber-attacks, are harder to ignore. They likely amount to signs of Russia stressing and probing European defences, and most importantly, testing the commitment of the US to NATO.

In this respect, NATO should be highly focused and motivated, but in the context of its gathering in Ankara, consistent with the view that all of the institutions of the post WW2 era are unravelling, dangerously on the brink of irrelevance. The danger is that it ceases to be an alliance, and instead serves as a mere organisation.

The reasons for this are well known. Whilst military level ties between the likes of France and America are very strong, Europeans (and Canadians) fear that Europe and the US no longer share the same enemy and worry that even in a post Trump 2.0 world, the stance of the US will not revert to an embrace of NATO.

In short, if NATO’s Article 5 was to be invoked, Europeans are still (despite comments from the summit) not convinced that the US would pick up the phone. Indeed, the only person to have triggered Article 5, Ambassador Nick Burns (former US ambassador to NATO who triggered Article 5 on 9/11) has said that Donald Trump’s repeated view that he wants to ‘take’ Greenland, is ‘breaking the bonds of trust’.

To that end, many officers in European armies increasingly regard the NATO command structure as an organisational framework through which European armies can coordinate, plan and organise, and to that end it still has value. Europe is re-arming, and as Germany showed this week, balance sheets are swelling with the issue of new debt to finance defence spending. This re-armament is urgent, in view of warnings from intelligence agencies of a clash with Russia within the next five years. One nod to this risk is the upgrading at the NATO summit of the Baltic Air Policing mission to an air defence one.

By their nature, democracies are vulnerable to the tactics of ‘total war’ and the rise of social media has made populism an easy and attractive strategy, and thoughtful rebuttal a near impossible one. Two important reminders of this came last week.

Nigel Farage, who according to some is Britain’s prime minister in waiting appears to have made a tactical error in resigning his Westminster seat, so as to recontest it. Farage did so in order to head off an inquiry into donations he has received (note that the former head of Reform in Wales is serving a lengthy jail sentence for pro-Russia bribery). With the exception of the satirical independent candidate Count Binface, no other parties will contest the seat, undermining Farage, with potentially enormous consequences for British politics given the rise in popularity of Reform.

Across the Channel, where on repeated occasions the French authorities have warned of foreign influence in French elections, the French judiciary have confirmed Marine Le Pen’s culpability in a finance scandal, but effectively opened the way for her to stand in the 2027 presidential election. The court battle is not yet over, and Le Pen will face several constraints (possible house arrest or electronic bracelet). Most voters should feel disdain in voting for a politician convicted of corruption, though Nicolas Sarkozy stills enjoys an allure in France.

But, Le Pen, whom Emmanuel Macron has accused of being funded by Russia, will likely play the martyr card, that the elitist French system is set against her. She has a hard-core support approaching 30% of the electorate, and the only person who can stop her is Edouard Philippe, the former prime minister, who has been far too mild mannered. He needs to take note from the evisceration of Keir Starmer, otherwise the next NATO summit in Tirana in 2027, may be marked by Marine Le Pen leading France out of NATO’s command structure.

Have a great week ahead, Mike

Modern Times

On May 15, 1932, there was an attempted coup d’etat in Japan, led by a militant, nationalistic faction in the Imperial Army. The principal victim was the Japanese Prime Minister, Inukai Tsuyoshi. The perpetrators of the coup were given relatively light prison sentences, a pointer to the less democratic and belligerent Japan that would soon follow.

The bizarre element of the coup, which fortunately did not succeed, was a plan to murder the actor Charlie Chaplin. The thinking was that such a deed would incite popular fury in the US, and thus lead to war, in which Japan would prevail. At the time of the coup, Chaplin was watching a sumo wrestling match with the Prime Minister’s son, and thereby escaped the assassins.

This was more than lucky and in many ways Chaplin’s film The Great Dictator is a fine riposte to the destructive nationalism and totalitarianism that took hold across the world from the mid 1930’s. It is a film that still resonates today in our world of ‘predators’.

While our view of Japan today is of a placid, highly civilized country, its history in the past two centuries is a reminder of the pitfalls of isolationism, nationalism and war – concerns that are now echoing louder across the international political economy debate. It should be said at the same time that the post second world war relationship between the US and Japan is a good example of how two feuding countries can come together (Al Alletzhauser’s ‘House of Nomura’ is good on this topic).

Yet, such was Japan’s economic rebound after the second world war that America feared the rise of Japan as it now does China, and fans of economic history may know that during the 1980’s and 1990’s Donald Trump was an eminent Japan-trade basher. For instance, the April 13 1987 cover of Time magazine carried an image of Uncle Sam pitted against a sumo wrestler under the banner ‘Trade Wars – the US gets tough with Japan’ (the stock market crashed five months later).

Now, following decades lost to the after-effects of its economic crisis, Japan is undergoing an awakening, spearheaded by the historic election of the first female prime minister of Japan, Sanae Takaichi. This awakening takes different forms, a more assertive diplomatic stance on China, a ramping up of defence spending amidst greater public comfort with the idea of Japan as a budding military power. Also, Japan’s government is ambitious for its economy and has announced a record state budget of 122 trillion yen (over Eur 600 bn), and Japanese firms like Softbank are in the vanguard of the AI boom.

There are two other financial aspects of this awakening. In an attempt to revitalize the Japanese economy, the Bank of Japan had kept interest rates at or below zero for some time. It has abandoned that policy recently and with both growth and inflation picking up, bond yields have surged. For much of the last fifteen years, the ten-year bond yield in Japan has been well below 1%, but in 2024-25 normalised toward the 1.5-2% range, and is now 2.7%, whilst the longer term 30-year bond yield is 3.95%.

As one of the world’s most indebted countries (Japan’s headline public debt to GDP ratio is well over 200% according to the IMF), the effect of this is that fiscal policy is increasingly smothered by the effect of interest payments on that debt, and policy is trapped between trying to grow the economy, control inflation and not upset the bond market.

Equally the yen is grabbing attention, falling to a forty-year low this week. Indeed, it might well be lower, but traders are wary of a market intervention by the Japanese authorities. There are several factors driving this, the hedging of foreign exchange risk by investors buying Japanese assets, real interest rate differentials, and worries over the effects of expansionary fiscal policy. A costly bout of yen intervention might be close.

As Japan’s asset prices hit records for largely the wrong reasons, it serves as a reminder that many large indebted economies exist on a financial tightrope between growth and calamity. Britain is the most prominent example, but Japan is a more systematic case and over the summer could be the source of a market wobble, if not outright crisis as bond market sell-offs become more common in our ‘age of debt’.

It’s all enough to make me think of Charlie Chaplin’s depression era film Modern Times.

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

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.