Spies Like Us

Ursula von der Leyen, the European Commission president, once led a mysterious life. Owing to death threats by the Red Army Faction against her father Ernst Albrecht, a prominent Christian Democrat, and suspicions that she might be kidnapped, she was sent to study in London, under the alias ‘Rose Ladson’. As such, von der Leyen is unfortunately acquainted with the types of security threats that are live across Europe.

In her State of the Union speech last Wednesday, geopolitics and security had top billing. In particular, Russia’s hybrid war in Europe (from sabotage to manipulation of elections, as we highlighted in a recent note, Russia Risks Rising) is enunciated as the main risk, and institutionalized measures are being put in place to counteract this. A full European Security Strategy will be unveiled this autumn, part of which is a NATO style Article 4 measure, where one European nation (likely including Norway, the UK and Canada) can draw upon the support of others. Indeed, the sense is of a Europe broadly preparing to assume the structures and processes of NATO, in the event that the US disengages from it.

It is likely that a component part of the new European Security Strategy will be a European Security Council, whose role may be to run crisis management, cross country procurement and to liaise with close EU partners such as the UK and Canada. In keeping with Jean Monnet’s dictum that Europe only moves forward in a crisis, it has required a war in Ukraine, conflagration across the Middle East, not to mention a very unexpected shift in foreign policy by the White House, to get Europe to this point. Given that its EU level diplomatic service has effectively failed, partly because of national level competences and rivalries, the EC needs to take care that the same does not happen in the realm of security.

One concern, that is so far registering behind the scenes, is a growing rivalry and even antagonism between the French and Germans in the areas of innovation, battle readiness and funding. Another more profound concern is that different EU countries have very disparate levels of competence when it comes to intelligence gathering and operations.

European nation states have been spying professionally for centuries, and Christopher Andrew’s excellent book ‘The Secret World’ makes this very clear. Some have allowed these skills to wither, and others have had to pivot to meet new challenges. Spain’s intelligence effort was almost entirely focused on domestic threats (separatists) up until the lethal Madrid bombings in March 2004, and thereafter it had to quickly build up an external facing capability. Other nations, from Sweden to Japan, are now augmenting their external-facing intelligence services.

In this context, the French magazine L’Express has, based on interviews with sixty former spies (including some agency chiefs), scored and ranked Europe’s intelligence agencies, and there is a very good discussion of the process in the Collimateur podcast. The runaway winner is MI6, on 261 points, followed by France’s DGSE on 169 points (judges apparently gave them high marks for their field operations), followed by the Netherlands on 97 points (renowned for their discretion and cyber capabilities). Then, maybe unsurprisingly in fourth is Ukraine’s secret service, given the extent of the challenges it has faced. Germany comes some way behind in fifth, followed mostly by the Nordic countries, Poland and Estonia.

A number of large countries are well down the list, such as Spain and notably Italy (Estonia gets 27 points as compared to Italy’s 9 points), as are wealthier countries Switzerland and Belgium. Austria and Portugal prop up the end of the list, and the likes of Hungary and Slovakia get zero scores, and according to the authors of the research report, are largely untrusted. Ireland did not feature. There are broadly two axes of strength, London/Paris and Den Haag, and the other to the north (Nordics/Baltics down to Poland). The south of Europe is weak, as are a number of EU members to the east.

Today, the majority of the intelligence agencies in Europe are united by the challenge presented by Russia, not to mention hybrid actors (gangs and cyber-attack groups) as well as some powerful corporate intelligence teams. There remains insufficient trust between many of them, and the opportunity for hostile actors to target weaker states is significant. Lurking behind the ranking is an ongoing reliance on US intelligence.

By that mark, Europe’s spies have a long way to go.

Have a great week ahead, Mike

The Rotten Heart of Europe

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

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

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

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

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

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

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

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

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

Have a great week ahead, Mike

Debt Purgatory

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

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

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

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

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

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

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

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

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

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

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

Everything is Fine

On September 16, 1992, the British pound was ejected from the rigid European Exchange Rate Mechanism (ERM) system that it had joined in 1990. In the ERM, the pound was linked to the Deutsche Mark but effectively at too high a valuation, making it uncompetitive. A few days later, Chancellor Norman Lamont tried to sound upbeat, telling journalists that ‘My wife said she had never heard me sing in my bath before,”, suggesting that he was happy to be rid of the ERM. This characteristic gaffe by Lamont was badly received at a time when British industry and households faced a sharp rise in interest rates.

The pound’s exit from the ERM came after painful interest rate hikes (from 10% to 15% in one day) and massive intervention from the Bank of England on one side of the foreign exchange market. On the other side, famously, was the speculator George Soros, who ‘broke the pound’ by selling billions of pounds in the expectation of a devaluation. At the time, a youngish Scott Bessent worked in Soros’ Quantum Fund. Today, as US Treasury Secretary, Bessent is having his ‘singing in the bath moment’.

Bessent has made two interventions in markets in the past month. The first, a historic joint move (the last one was in 1998) with the Japanese authorities to boost the yen. The involvement of the Treasury ensured that Japan was able to buy yen without selling Treasuries, which would have pushed US yields up. In that context, Bessent’s second intervention was a promise to effectively sell short duration bonds, and with the proceeds buy long duration ones, the intention being to push down long-term yields.

Bessent’s moves were greeted with puzzlement and some disdain in markets. Interventions in markets are rare, normally occuring when something is broken or about to break. When they do occur, they need to be large (almost unlimited) to have credibility. Mario Draghi’s announcement that the ECB ‘would do what it takes…and believe me it will be enough’ is the best example. Thus, the Treasury Secretary’s interventions give the impression that something is not quite right, and in this regard, at least three problematic issues are raised.

The first is that Bessent has announced the arrival of a debt crisis, or rather a debt purgatory, a long period where indebtedness weighs on government policy, markets, and geopolitics. The bond market intervention coincided with America’s debt burden topping the USD 40 trillion mark, and the Treasury Secretary has simply succeeded in drawing greater attention to this.

Markets registered this in May when long dated (30-year) bond yields on US, UK and Japanese debt hit levels not seen since before the global financial crisis. Bessent’s intervention shows that governments are now feeling the financial pain associated with this rise in yields and are starting to worry about how to curb it. A particular problem for the US, is that a mixture of geopolitics and AI driven debt issuance, mean that there are fewer natural or passive buyers of its debt.

The second element of note in Bessent’s actions is that they betray a philosophy across the Trump administration that is intensely focused on asset prices to the detriment of economic policy. The president’s active stock trading and public promotion of stock trades, billion-dollar forays into cryptocurrencies, and attempts to shepherd the oil price through social media are all part of this. At the same time, the US has a historically enormous budget deficit, which the rating agency Fitch expects to surpass 7%. In the past a deficit of such magnitude would only occur during a deep recession or financial crisis.

Today, in the context of a record high stock market, and an AI boom, it is a dangerous anomaly. Should something go wrong to pitch the US into a recession, there is no fiscal cushion. Bessent has done nothing to reduce the deficit and his tinkering in the bond market shows that the deficit is not his priority.

Thirdly, the bond market intervention is ill timed because the other ‘wing’ of American financial policy, the Federal Reserve, has a new chief, Kevin Warsh, also a former hedge fund manager. Warsh has a preference for a Fed that communicates less to markets, but he has so far not communicated well. Markets are unsure of his stance on inflation. The added complication is that Warsh prefers a more spartan Fed, one that is less active in bond markets, so the Treasury intervention is a contradiction of this. The other concern is that the Fed begins to suffer from fiscal dominance, which in simple terms means that in making policy, it is looking over its shoulder at the actions of the Treasury, and the sentiment in a wobbly bond market.

With markets still focused on AI, Bessent has unwittingly opened up a macro ‘battle’, which the bond market will surely win.

Have a great week ahead, Mike

Friends

An important sign that globalization is over and that America’s role as the keystone of the world order is crumbling is the flux in strategic alliances between countries, across multiple regions. Arguably there has not been a period of such furtive strategic alliance formation since before the Cold War. Globalization was a geopolitical anomaly in the sense that there were no major wars, international norms, rules of geopolitical behaviour and institutions were respected. This is certainly not the case today, and the idea of ‘fracturing’ we wrote about in 2020 is accelerating.

Sweden and Finland reacted to the invasion of Ukraine by joining NATO. Next week (29^th) Iceland will vote to recommence membership negotiations with the EU and potentially join Moldova and Ukraine in the accession queue. Iceland had toyed with membership in the aftermath of the global financial crisis and the consensus in the small country is once again turning to Europe, because of ‘geopolitics’, by which Icelanders mean the presence of Russia in the Arctic and greater Nordic region, and American threats to ‘take’ Greeenland.

The Iran War will eventually provoke a re-alignment of alliances across the region, where the crucial variable is the relationship between the UAE and Saudi Arabia. Two weeks ago, Saudi Arabia, Pakistan and Turkey signed a joint defense pact in Mecca, an accord that has strategic implications for Iran, Israel and notably, India. During the period of globalization, Turkish foreign policy was conditioned by the maxim ‘no trouble with neighbours’. Now, Turkey is involved in some form, in every skirmish in the region – from Libya, to Syria, to Azerbaijan to Iraq.

Then in Asia, relatively new ‘clubs’ have been forming; AUKUS (effectively a US – Australia alliance), the Quad (Japan, the US, India and Australia) and the Shanghai Cooperation Organisation (China, Russia and Pakistan are the main members). For their part, South Korea, Japan and Taiwan, all formal allies of the US, will be worried by the gradual strategic distance that the White House is putting between its Asian allies, the most recent is the curtailing of joint military training exercises between American and South Korean forces.

Most of these alliances are motivated by a common factor; an America that is more singular, and less willing to be the world’s policeman. This change is complicated by the fact that the White House appears to have a fascination for autocrats (for example, Steve Witkoff, President Trump’s peace emissary has not visited Ukraine, but is a frequent visitor to Moscow). Indeed, some of the critics of the White House’s foreign policy stance, such as Harvard academic Stephen Walt, go a step further and have referred to the US as a ‘predatory hegemon’.

The net effect is that many countries will now experience the loss of the ‘policeman premium’ they enjoyed when America underwrote their defence, and instead will have to pay a ‘predator premium’; the higher security and defence costs associated with a more adversarial geopolitical climate. Germany is the case in point, where military spending and combat readiness had dwindled during the period of globalizations, but where it has now lifted its debt brake and will spend up to Eur 1 trillion on defence in the coming ten years. Corporates are also facing this defence friction – either through supply chain disruption, cyber-attacks or the theft of corporate secrets to the extent that corporate intelligence is a fast-growing field (Lewis Sage-Passant’s book ‘Beyond States and Spies’ is a very good text here).

The kaleidoscopic shift in alliances will likely continue, and a cautionary tale is the manner in which the tangled web of alliances that sprung up during the first wave of globalization (1870-1913) tripped itself up. Then Europe was split between the Triple Alliance (Germany, Italy and Austria/Hungary) and the Triple Entente (Britain, France and Russia). Margaret MacMillan’s books on the First World War (for example ‘The War That Ended Peace’) are worth a read and the parallel in the arms race between Britain and Germany then, and China and the US now, is striking.

Alarmists might worry that a ‘great power’ war is close, but the only saving grace from the wars in Iran and Ukraine, is that the great military powers struggle to achieve their aims in the face of new technologies and tactics. Let’s hope they learn these lessons.

Have a great week ahead, Mike

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