The Fracturing continues – from Tehran to Taiwan

Sykes Picot divides the Middle East

A friend of mine, who is also a successful sportsman (rower) once told me that he trains every Christmas day, just in case his competitors take that day off. It is a quirky piece of advice but one that I have long since borne in mind.

Thus, as I returned home from my Christmas morning run, I was interested to read that Russia, China and Iran – were using the Christmas period for a naval training mission in the Gulf of Oman. Presumably, like my friend, they thought the US and its allies were taking Christmas day off.

The exercise points to the emerging rivalries of the 21st century. China and Russia are members of the Shanghai Cooperation Organisation (SCO), which readers of the Levelling will know that I consider to be one of the geopolitical ‘gangs’ of the future. Their rival regional gang is the ‘Quad’ (India, USA, Japan and Australia).

The significance of the SCO, and the recent exercise with Iran, has now been heightened by the killing of Iranian general Quassem Soleimani. Indeed, it is just one of many implications (by the way in my last missive before Christmas I noted that in 1998 Bill Clinton had responded to impeachment by launching an airstrike on Iraq, and that another President might try the same tactic).  

The immediate one is that the USA will find its moral and diplomatic power diminished, and both its allies and foes again demanding whether the White House has a coherent approach to policy making (Israel’s muted reaction was telling).

For example, the missile strike on Soleimani cuts across an increasingly successful financial and clandestine war against Iran that was producing inflation, unrest and a surge in crime across the country. The airstrike will now allow the Iranian regime to paint its socio-economic troubles as being generated by the hand of the CIA and MI6 (there is a long held, view across Iran that foreign spy agencies are behind political and economic turmoil in the country).  

The killing of Soleimani also means a likely diminution in the American presence in Iraq, that Americans are less rather than more safe, and an altogether more uncertain outlook for some of the smaller states in the region, notably Bahrain, Dubai and Abu Dhabi. While the tension between both Iran and the US is perceived to have diminished following the Iranian riposte, I think this dispute is not over, and the event itself will lead to a hardening of attitudes.

To return to the SCO, Soleimani’s death will underline the rationale for this grouping and we should expect to see it become more prominent. Russia in particular may now look to play a stronger role in the long term future of Iraq and Syria (potentially with the backing of Chinese capital).

Russians will underline how the Kremlin was both concerned and emboldened by the 2003 invasion of Iraq, that it later took aggressive measures to defend what it perceived were threats to its hinterland (in Georgia and Ukraine).

At a grander level, the killing of Soleimani will cause tension within NATO, and will heighten calls by many for an EU army, that can at some stage have the capacity to act alone, though with the US under the NATO umbrella. It should also, at least in terms of the security and foreign policy push the UK towards rather than away from the EU, and in my view this partnership could well be one of the more stable pillars in the post Brexit relationship.

In sum, this critical event points to some near-term event risk, notwithstanding the apparent de-escalation (Iran’s public de-escalation points to stealth retribution), and an elevation of longer-term geopolitical risk (and by extension political risk in the US in the context of the election).

Geopolitical risk, or rather geopolitical events, rarely trouble broad equity and debt markets but my worry is that we are now seeing a fracturing of the world order (this weekend’s Taiwan election is a case in point and expect the newspaper pundits to talk of Taixit from Sunday), and the emergence of a one where geopolitical friction becomes the norm. Expect this to be increasingly reflected in the securities of pan-global companies, certain emerging market debt securities and in safe haven assets.

The real reason for calm across markets is central bank liquidity. They are the monetary battleships of the 21st century, more powerful than many armies. What might happen if they are deployed in a conflict?

Have a great week ahead,

Mike

Remaking a World on Fire

Notre Dame – a sign of the times?

It has been an eventful year for me, but the most striking moment was witnessing the fire at Notre Dame cathedral. Having run towards it, I was unprepared for the extent of the conflagration, green and orange flames bellowing out of the church as the sun blazed angrily in the background. It was a traumatic evening, where thousands of onlookers were silenced by the significance of what they saw.

At the same time, it would be wrong of me to try to draw a parallel between such an apocalyptic event and the state of our fracturing world, though that thought is at the back of my head, not least given the way in which the ‘old’ world order is increasingly vandalized by politicians, not to mention the outbreak of protests around the world.

A better parallel, as supersized cranes moved around Notre Dame this week, is that the time it will take to rebuild and remake the church, some five or more years, will also be the period of time required to put the era of globalization behind us and have the makings of the ‘next world order’.

The roadmap towards this ‘order’ will look something like this – economically the world will grapple with the ‘next recession’ which will be more severe in indebted economic sectors (China’s economy, corporate USA and some emerging countries), and will eventually culminate in some form of world debt conference. Once this is accomplished, the quest for a model of organic economic growth will begin.

Politically, I hope that we will see more independent, bottom up efforts by individuals and new groups/parties to rethink what the contract between people and those who govern for them will look like. Then in terms of geopolitics, the world will be increasingly dominated by the ways in which the three great ‘powers’ – the EU, USA and China pursue different paths on issues like the internet, democracy, human development and finance. This is a limited, big picture sketch, the rest is of course in the Levelling.

Forecasting – really more a form of ‘macrotainment’ than a science – is easier on a five year view, but given it is the end of the year, I also want to offer up a few pointers on at least two events over the next few months.

First, I expect economic and political headlines to be first driven by the unravelling of China’s credit boom – we will hear more about defaults of indebted Chinese companies and resulting pressure on its banks. Expect ‘China is Spain’ to be a headline we see a lot. The policy task for China’s leaders will be complicated by ongoing protests in Hong Kong and importantly, the result of Presidential elections in Taiwan on January 11th. My guess is that one result will be a drop in Chinese interest rates in 2020.

Second, impeachment will deepen America’s divides. With the process now started, it looks for right or wrong, that the Senate will not vote to impeach President Trump. The trial itself, especially if likes of Mick Mulvaney and John Bolton are called as witnesses, will prove a spectacle.

If we bear in mind that Bill Clinton responded to his impeachment with airstrikes on Iraq, then Trump’s emotional letter to Senators is mild by comparison. He may try other means of weaponizing impeachment – link it to the stock market (Trump has sent 21 tweets about the stock market in the last 30 days, the most since 2018), trade policy with Europe or immigration.

The immediate political implication of the Senate not impeaching the President is that the Democrats lose their ‘silver bullet’ against Trump, and with it the sense that morality, the law and institutions are powerful buttresses against bad behavior. In turn, this will colour the Democratic Presidential selection process. The Democratic candidate will need to have a very clear policy message, an ability to scrap with Trump in the political gutter (see my October 13 blog ‘Don the Robber’, https://thelevelling.blog/2019/10/13/donthe-robber/). So far, none of the leading Democratic candidates is strong on these points (someone like Mike Duggan of Detroit could fit this bill in my view).

For Trump, and his supporters, a failed impeachment will open up the road to the acceleration of his policies on immigration, trade (EU) and on identity-based politics. Mounting, structural risks like climate damage and indebtedness will get worse. The next election will be driven by identity, race and values, and there is a very good chance that Trump could win.

So, enjoy this Christmas, there is plenty of disruption to come in 2020!

I am back in touch on January 12.

With best wishes, Mike

Deal done – Trump saves euro!

Wrong way!

In a missive I wrote earlier this year I puzzled whether Trump would fall victim to the same policy mistakes as Herbert Hoover (‘Is Trump Hoover?’,https://thelevelling.blog/2019/08/11/is-trump-hoover/). This does increasingly look to be the case, as the economy is slowed down by the debilitating consequences of trump’s trade war with China.

However, a reading of the Art of the Deal (consider quotes like ‘I’m the first to admit that I am very competitive and that I’ll do nearly anything within legal bounds to win. Sometimes, part of making a deal is denigrating your competition’) hint at some method behind this week’s trade related threats to China, the EU and France, not to mention the ongoing undermining of NATO.

It grants far too much credit to Donald Trump to describe him as the architect of a new world order, rather he is the bull in a china shop of increasingly brittle crockery. His role, in the context of the fracturing of the old, globalized word order is to help highlight what elements in that world order are fragile and which ones are resilient. The checks and balances in the US political system, and the wisdom embedded in them through the Federalist Papers for instance, are so far proving resilient.

Arriving in Europe this week, Trump clearly had two targets in mind – the EU and NATO, both of which lie on the deepening faultline of the consequences of America’s diplomatic estrangement from Europe. Trump has rarely had anything better to offer either institution save scorn and division. In my view this is a pity, and simply wrong.

NATO and the EU are fine examples of how collective action usually requires a strong common cause to enforce it, and that absent the magnetism of that common cause (broadly speaking the Cold War), cohesion between members begins to ebb. In addition, both institutions are finding that they have a common design flaw – namely the lack of an exit. Neither NATO nor the EU (not to mention the euro-zone) have processes where a recalcitrant member can be kicked out. Brexit shows us that even those who volunteer to leave, find it difficult.

To make an analogy, no public building can be used without a fire escape or carefully marked ‘exit’ in place, and it should be the same for multi-lateral institutions in a changing, multipolar world. This multipolar world is one where nations will increasingly have to take sides. In this context, Turkey’s membership of NATO will become increasingly problematic, and the position of EU members like Hungary, and prospective candidates like Serbia also looks strained. My prediction is that both NATO and the EU will have to change their uni-directional membership rules to include a ‘black-balling’ process.

That NATO rests on the emerging faultline of US-EU relations gives us a clue as to its future. The logical contradiction is that the White House could soon declare a trade war on Europe, at the same time as partnering with the EU to fight ‘real’ wars. To paraphrase Justin Trudeau, it is enough to make ‘jaws drop’, though it is not as peculiar as it seems. For instance, in October, as the final wrangling over the UK’s Brexit deal was taking place, French commandos joined their British counterparts in a joint operation called ‘Griffin Strike’, part of a larger cooperative exercise between Europe’s two military powers.

One way for the EU to contribute to its own security in the context of a multipolar world where the US is a less unambiguous ally, apart from making sure its military kit works (only one sixth of German helicopters and fighter planes are operational), is to develop its power as an economic and financial player.

Theoretically this approach fits into the ‘total war’ doctrine developed by Russian General Valery Gerasimov, where financial networks are just as useful strategic tools as fleets of submarines. The effect of American sanctions on Iran is one recent, powerful example of this.

To that end, the new Commission has a long task list, but it should focus on the following. First, bolster the international credibility of the euro by enforcing the Maastricht guidelines of debt levels to the point that countries with debt above the Maastricht threshold should have a portion of their debt deemed ineligible for ECB purchases and for collateral exchange.

Second, continue to clean up the follow of ‘dirty’ money across Europe’s banks and fintech players. The relatively new EBA (European Banking Authority) has failed to do this.  Third, think how infrastructure development in countries like Poland and Greece can be better supported by the EU and by EU based private investors, instead of those countries swaying towards Chinese state led investment.

If these and are other measures are enacted, Donald Trump may prove the catalyst for a stronger euro financial system.

Have a great week ahead,

Mike

Ne vous mêlez pas du pain

Food set to become a controversial geopolitical issue

‘Ne vous mêlez pas du pain’ – do not meddle with bread, is the sound advice that Anne Robert Turgot, the 18th century French economic thinker and administrator gave to Louis XVI. It was good advice, which the King did not heed.

Turgot knew better, he was Controller General of Finances in France between 1774-1776, a period marked by the ‘Flour Wars’ when bad harvests pushed up the price of grain, and consequently, bread. The riots were a precursor to the Revolution, at a time when nearly half of disposable income was spent on basic foods like bread (and salt).

The link between food prices and unrest has held since then (and has a pedigree going back to and beyond the Roman Empire). In 2007 as dollar and commodity price volatility marked the beginning of the global financial crisis, a spike in soft (agricultural) commodities led to unrest in countries as diverse as Haiti, Mozambique and Bangladesh.

Then four years later, a spike in grain and other food prices catalyzed the Arab Spring, markedly so in Egypt which is highly vulnerable from the point food security. Some countries in the region, notably Kuwait, ducked such unrest by introducing grants and subsidising food consumption for over a year.  

The case of the Arab Spring underlines two other factors, both also found in the likes of Venezuela today. First, rising food prices are usually the ‘last straw’ for citizens in countries that are badly run, corrupt, suffer poor institutions and that are often also oppressive. Second, in many of these countries, as in pre-Revolutionary France, staple food stuffs like bread make up between one third to one half of discretionary spending.

This was the case in India in recent years, where spikes, or more appropriately bubbles in onion prices led to political agitation. For example, in mid 2013 there was fivefold spike in the price on onions, partly due to shortages, partly due to hoarding. Similar, dramatic spikes have occurred to garlic prices in China.

Since that period (2012-2013) world food prices have thankfully been stable, according to the UN FAO global food price index. One area of recent turbulence which is worth watching is pork prices in China. Swine fever has led to a sharp rise in the price of pork, which because foodstuffs account for some 30% of China’s inflation basket, has driven CPI (consumer price inflation) to 3%, close to its highs of the last eight years.

While China is not at all as fragile as Egypt, the spike in pork prices if it persists, will have a number of short and longer term macro impacts, one of which is that China may not have the demand for the 20 billion dollars or so of soya beans it has promised to purchase from the USA.

Chinese consumers will feel more constrained, and the rise in prices will, in the context of weaker property prices, contribute to a sense of ‘squeeze’ (recall the phrase ‘squeezed middle’ (class) in England). Relatedly, higher headline inflation makes it more difficult for the People’s Bank of China to cushion weakness in the economy with rate cuts.

The spike in pork prices is also a reminder of how food is at the centre of geopolitics. China, though vast, has a relatively constrained arable land mass, and will in the future have to import more food as well as try to buy land or crop facilities in other countries. Other food ‘vulnerable’ countries are India, Indonesia, the Democratic Republic of Congo (DRC), Bangladesh, Pakistan, and Ethiopia. Global warming and diminishing water supplies in many of these countries may mean that food security becomes an even more acute risk factor.

In contrast, the US has vast expanses of farmland, a good chunk of which could be used for food stuffs if it were not for ethanol subsidies. In the future, it may use food in an altogether more strategic way.

In the shorter term, the investment impact of higher pork prices is to make Chinese consumers nervier, to constrain policy makers there.  That means that demand for hard commodities like oil and copper will be muted, Chinese interest rates volatile and overseas food producers more attractive.

Further out, trade wars may give way to food wars.

Have a great week ahead,
Mike

Lessons from Brexit, so far

Brexit, washed away

In the past week a short video clip of Laurel and Hardy’s struggle to get away on holiday, under the title ‘How England plan to leave the EU’, has gone viral (especially so in the German speaking world). Whilst an uncharitable view, European leaders are as I write, discussing a second Brexit extension, and the prospect of a Christmas general election in Britain is now high.

In my view the first part of Brexit is almost over, in the sense that terms now seem to have been agreed between the EU and London. The potential scenarios are now narrowing, and point towards a less disruptive form of Brexit in the near future. Against that backdrop, where I caveat plenty can go wrong, it is time to begin to draw some lessons from Brexit, especially as other parts of the world become more agitated.

In many respects Brexit is a global event because it was the first rupture in a world where the liberal order is being levelled, and where a sense of the fractured and chaos are now normal. The second such rupture was the election of Donald Trump, and today events in Hong Kong, Chile and Syria illustrate the emerging democratic, economic and geopolitical faultlines, where American policy in particular will be tested.

The savage and unpredictable political process that is Brexit has produced very few winners, but for observers outside the UK there are clear lessons.

One, which is ever important ahead of the 2020 election, is that unless issues like immigration, national identity austerity, declining human development (think education attainment and healthcare standards) are correctly channeled, they will destroy a nation. Britain is bitterly divided because of Brexit, as is the US by Donald Trump.

In Britain, previously sacrosanct roles such as that of the Queen, the functioning of Parliament and the Constitution has been pushed to breaking point, as it should be said, has any sense of ‘truth’ in politics. Like America, Britain’s checks and balances are just about holding up. That few political leaders today could pen something like the Federalist Papers is just one reason for Americans to revere its constitutional heritage. Hong Kong, and arguably the increasingly ‘managed democracies’ of Eastern Europe echo this tension.

Geopolitically, the European Union (EU) has emerged from Brexit with the lesson that when it is united, its size and technocracy are formidable. For all the castigation of the EU by British politicians, it has thoroughly outclassed London. The White House should take notice of this in case it considers a trade war with the EU.

In Brussels today, where a new Commission is soon to take office, Brexit is becoming a side issue and there is more and more attention being paid to the role that the EU needs to play in a multipolar world. Here it is stealing a march on the US and China, in two respects. The values of liberal democracy are more consistently being enunciated by European leaders, and the EU is fast becoming the first mover in setting the rules and regulations that govern new technologies.

More locally, one of the dramatic side-effects of Brexit is the way it has detonated the historic relationships between Ireland, England and Scotland. Scotland will very likely become an independent state in five years time, there is growing talk of a united Ireland, and Ireland itself will be the only EU country with strong cultural ties to the USA.

What happens to Scotland and Northern Ireland is a key part of the next chapter of Brexit. Scotland will need to think more clearly about its economic model as an independent country, and on the merits of being an EU member. Northern Ireland, whose socio-economic problems have long been neglected by London, arguably needs a Marshall style plan to transform its economy which is heavily dependent on state disbursements, and that needs to follow the example of social investment in countries like Sweden and Switzerland.

Then finally, what Britain (effectively England) does next after Brexit will be a vital lead indicator of where other countries can go in a world where globalization is being levelled out. One avenue is a purgatory of post Brexit recrimination, a lack of leadership to tackle underinvestment and a susceptibility to nationalism.

Another, more optimistic one that could reflect the best instincts of Britain is that a new generation of political leaders comes through to replace the likes of Boris Johnson and Jeremy Corbyn. They would then begin to tackle the many policy issues that have been given little thought as Brexit has raged on – the need for the UK to develop a new economic model especially one that focuses on the potential of its regions, what role the UK plays as a mid-sized geo-political power and the need to focus policy much more on human development issues like mental health and education.

You never know, the same might just happen beyond the shores of the UK.

Have a great week ahead,

Mike

The Dude, Don and the dollar

Diplomacy, Trump style

In an increasingly fractured world there are still some things that unit the most disparate countries. In recent years a trader, named ‘the Dude’, has popped up in Turkey’s financial markets. ‘The Dude’ has been known to trade in huge volumes, on occasions boosting the average volume of the Istanbul Exchange by up to 10%.

He came to mind last week after I read William Cohan’s fascinating article in Vanity Fair where he detailed a range of enormous trades in the S&P futures market that appear to have taken place just before market moving tweets from the US President. Regular market participants have been left flummoxed by the size and prescience of these trades, and it is to be hoped that the market regulator will get to the bottom of the matter. However, one cannot help pondering the identity of these ‘Dude’ like traders.

Beyond trading, there is oddly, much ore that unites Turkey and the USA. Turkey has become the graveyard of US diplomacy as the sanctioning of the Turkish army’s incursion into northern Syria by President Trump arks the end of the moral, democratic and military backstop that American has extended to the rest of the world for the past seventy years.

That Mikes Pence and Pompeo have only managed to agree a stay of execution for the Kurds illustrates the atrophying in American power, and the schoolboy-ish letter that President Trump sent to his Turkish counterpart makes matters even worse.  

Economically, Turkey has two interrelated lessons for the USA and the rest of the world. First, Turkey is a salient tale in the rise and fall of nations. Since the early 2000’s when Kemal Dervis had righted the banking system and the prospect of membership of the EU was dangled in front of it, Turkey made great progress. Lately this has come to a halt as policy making, the quality of institutions and the rule of law have been degraded.

It leads me to think of Edward Gibbon’s ‘A History of the Decline and Fall of the Roman Empire.’ Gibbon, who sought to explain why the Roman Empire disintegrated believed that Rome became complacent, institutions weakened and the leaders in Roman public life lost their sense of civic virtue (or what Machiavelli later simply called ‘virtu’ – the good of the republic or common good).

The importance of institutional quality and the need for a sense of civic ethic is evident in other books that track the rise and fall of nations such as Acemoglu and Robinson’s ‘Why Nation’s Fail?’.

Acemoglu, like Dani Rodrik, is one of the leading economists in the world, and Turkish. Both of them I am sure, lament the direction that their country has taken, and both would have clear policy answers to set it back on course. Both are based in Boston, and it is hard not to think that their work (Acemoglu and Robinson have a new book out, ‘The Narrow Corridor’), as well of course as that of Gibbon, deserves reading in Washington.

It might also be more widely read on Wall Street, because as Turkey again shows, political risk is becoming a greater force in markets. Typically, and doubly so in the age of quantitative easing (QE), political and geopolitical risk have not played a significant role in developed economy markets.  The behavior of the Turkish lira, its debt and equity markets in the past three years suggests that for emerging markets at least, political risk is now a dominant market factor.

The case of Brexit and sterling suggest that developed markets are not immune. The perplexing issue however, is how investors (at least those who, to go back to William Cohan’s article, do not have premonitions of market turning tweets) can react to heightened policy uncertainty.

The puzzle is deepened by the fact that number of measures of policy uncertainty are at all time highs, while volatility is close to its historic lows. Indeed, for most investors the political risk they are most concerned about is the prospect of an Elizabeth Warren Presidency, which whilst arguably good for American institutions could be tough on corporate profits and taxes.

Back to the current incumbent of the White House, who is attacking his country’s central bank and institutions with nearly the same vigour that Mr Erdogan is employing in Turkey.

The reason that the dollar is not as volatile as the lira is that it is the reserve currency in a reasonably healthy economy in a world where most other large economies are weak. For dollar based investors however, dollar strength is a good opportunity to diversify, especially for those who think that the ‘American empire’ has peaked. In the shorter term, hedges such as gold and equity volatility, are beginning to look more attractive. If the ‘Dude’ sized trader in the S&P futures market is found out, they may be doubly interesting.  

Have a great week ahead,

Mike

@Donthe Robber

Watch out

Donald Trump’s reneging of the Kurds in northern Syria, his cynical treatment of Ukraine and his weak ambivalence on the Hong Kong protest movement may fit the pattern of his usual behavior, but to those outside the US these developments cut away the moral, military and diplomatic backstops that the US has provided to rest of the world for the last seventy years.

These acts pull up the drawbridge on the old liberal order, and now set in motion a fragmenting world of ‘patriots’, as he might put it. Another four years will render this regression permanent, with many yet unseen, negative consequences.

While many Americans will be happy that President Trump is committing fewer resources to what are other people’s problems, they must also realize that the cost of this is the end to American exceptionalism – this will have long lasting implications for the dollar, US multinationals, the security of America and Americans, for American culture and even for basketball.

For those who care about these things there are several things that can be done.

To start, technocrats, former public servants or even ‘experts’ from the military, economic policy, diplomacy and human development led sectors like education, need to speak loudly and clearly about the damage being done to America’s credibility, its institutions and human capital. Jim Mattis for example, entirely missed the opportunity to do this with his recent book.

Then, moderate Republicans, who if they have a sliver of moral courage and an ounce of sense, must start to put the future of the US – at home and abroad – ahead of career expediency. As it stands, they are more supine than many of the emerging nation governments they disdain. The very least they can do is stop blocking the rule of law, and the cloaking of the transparency of government.

As this occurs, the President will fight back. His greatest talents are his ability as a gutter scrapper, and his instinct for how to caricature his opponent’s weaknesses. He flatters and bullies, belying his own foibles. What no Democrat, or Republican for that matter has done so far, is to match him in this respect. Some might feel it is beneath them but it is the only way to loosen his electoral base.

Whomever succeeds in taking on the President will need to show that @DontheRobber is robbing the future to prop up the scam that the present is ‘great’. Corporate tax cuts, an alarming rise in corporate and government debt and a fiscal deficit that is unusually large for an economy in expansion, have all boosted the economy in the past three years, to cripple it in the future.

Record levels of wealth inequality rob the public in general, and the next generation. Equally, a short-term focus on a damaging trade war is disturbing corporate investment and supply chains, while the lack of real investment in education will rob the economy of a key source of productivity. Blindness to the consequences of climate change will rob many of the President’s supporters of their livelihoods as we move into the 2020’s.

The trade agreement with China, yet to be finalized, is a fine case in point. It falls far short of the terms that had initially been proposed, doesn’t at all tackle the concerns corporate America had and leaves open too many points of uncertainty. To their credit, the Chinese have done very well here.

In politics, the modus operandi of the President and those who enable him is robbing public life of any vestige of civility and fraternity, and risking divisions that will carry through this century.

The sense that America, its social fabric and its economy, are being robbed is just one, clear way of encapsulating the consequences of current policy making from the White House. It is now breaking old conventions, alliances and economic relationships on a nearly daily basis, and the cost of this needs to be made tangibly clear to Americans, lest the country, like a real estate speculation gone wrong, is sold away to opportunists.

Have a great week ahead,

Mike

A World of Patriots and Dreamers

China marching on, obstacles ahead

Last week’s UN General Assembly reflected a number of emerging trends – the miring of public life in older democracies (US and the UK) in banality and controversy, and the flourishing of climate change as a mainstream political issue, are just two.

These trends are part of the fracturing of the old-world order, and pointers as to where the new order may lie. Underlying each of them is the contentious issue of how political debate is conducted.

One striking statement at the UN was President Trump’s remark that ‘The future does not belong to globalists. The future belongs to patriots’. Practically, coming from the leader of the world’s superpower it is another nail in the coffin of globalization, in addition to being an embarrassing conflation of the meaning of nationalism with patriotism.

One of the ironies in Trump’s many grand statements is the way they echo in China. In fact, China is well ahead of Trump in conceiving of how to put the ‘country ahead of the global’. A memorable example was the 2017 World Economic Forum when the Chinese leader Xi Jinping made a speech that claimed the mantle of globalization for China (from the USA).

The curious aspect of this is that while China is a large spigot in the world economy, it is one of the least globalized countries in the world (it ranks in the bottom quarter of nations according to my own measure of globalization). In his own way, Trump is reacting to this, but his crude view of China does not do justice to its history nor the amplitude of its ambition.

Well before MAGA (Make America Great Again) Xi Jinping coined the term ‘China Dream’ in a speech when visiting the National Museum of China in November 2012, having taken the office of general secretary of the Communist Party. The 70th anniversary of the founding of the People’s Republic which occurs next Tuesday 1st October, will bring this into sharper focus.

China’s view of itself in the future, or the Chinese Dream, is colored by past generations of economic and cultural greatness. Recall that at the time of the Founding Fathers, the United States was but an emerging, even frontier economy and that at that time China accounted for nearly 40 percent of the world economy. By 1950, 150 years later, America made up a third of world economy, and China’s share had shrunk to 10 percent.

Given this backdrop China wants to elevate itself to a position of economic power (perhaps regional dominance) and of policy power in Asia with its own regionally relevant rule-based order so that it is, at the very least, not subject to the domination of Western countries and institutions (the film Amazing China, to be found on Youtube,gives a sense of this and of what is ahead).

China’s rise over the past thirty years has not been given enough credit by commentators and politicians in the West. Few of them are really curious about Chinese history and the Chinese approach to economics, politics and society. Mike Pence’s speech to the Hudson Institute last October was a sign of this, and one of the great challenges China will face in coming years is the realization in Washington and Brussels that China is pulling level with them in some domains.

Looking ahead, the great risk for China is that the ‘Dream’ runs out of momentum, economically in that growth slows, and politically in that people in China question a model that exchanges liberty for stability. The underlying risk is that not having experienced a formal recession in close to twenty years there is a great deal of inefficient capacity built up in China and that a downturn will expose this. If it does, rising unemployment will create a new political challenge for the all-powerful Xi Jinping.

In this respect, the manner in which China manages the protests in Hong Kong will provide a clue as to how the Communist Party will manage emerging political challenges. A physical, confrontational approach will open up many risks – political contagion, sanctions on the Hong Kong economy and a loss of soft power. A more drawn out approach that contests the legitimacy of the ‘two systems’ and that penalizes locals in Hong Kong by slowing the local economy may well dampen the crisis from a Chinese perspective. It must then confront the tenor of elections in Taiwan in early 2020.

Political volatility is thought to be the preserve of the West. One of the great surprises of the early 2020’s may be the way it spreads across emerging countries, with China as no exception.

Have a great week ahead,

Mike

Is Trump Hoover?

Herbert Hoover in better times

Over a week ago I penned an article for Dow Jones/Marketwatch where I predicted (note that I only use this verb after the event) that the recent rate cut by the Federal Reserve would mark the top for equities. The subsequent volatility, and of course last week’s missive on the yuan, prove me to be a financial market genius.

More seriously, recent volatility is a reminder of the fragility of investor behavior and of the risks lurking in the global economy. On a longer scale, as we approach September, they are a reminder that while the global financial crisis of 2008 did not quite end in an economic depression, neither has it produced a true economic renaissance. Many of the factors that caused the crisis in the first place—indebtedness, corporate risk taking and poor governance—have simply been in abeyance, hibernating, and are now again emerging into the daylight.

One consequence of these persistence economic fault lines is that we are in a political depression. In this light, some respected commentators—notably, Madeleine Albright in her book Fascism: A Warning—draw parallels between political figures today and those of the 1920s and ’30s. Recent events in the US, and comments by the President reinforce the parallel.

In ‘The Levelling’ my intention is to avoid the gloomier comparisons with the 1920’s/30’s, but the deepening trade dispute between the US and China makes them inevitable. One reason that President Trump has been eager to push the Federal Reserve to cut interest rates is that he ‘doesn’t want to be the next Hoover’.

Other commentators have already been making this comparison with Herbert Hoover (President from 1929 to 1933). Paul Krugman recently wrote that the level of tariffs applied by the Trump administration is now close to that of the Great Depression.

Hoover was different to Trump in that he distinguished himself in various ways, notably in his humanitarian work in Belgium with the US Food and Drug Administration, and in Central Europe in the aftermath of the First World War.

In other ways, he has several things in common with President Trump: German/British parentage, a business background, and a mastery of new communications channels, in Hoover’s case the use of radio (rather than Twitter) to reach voters and the introduction of the press conference as a regular political event.

Furthermore, the trade dispute between the United States and China has excited commentators who fear that Trump may repeat the mistakes of the Hoover government. Even the Wall Street Journal editorial team warned last year that the Trump trade team is like Senator Reed Smoot and Representative Willis Hawley, promotors of the disastrous 1930 Smoot-Hawley Tariff Act. The same newspaper now talks of a ‘Navarro Recession’, in honour of Trump’s trade adviser Peter Navarro.

 The Act aided and abetted the onset of the Great Depression with the introduction of tariffs of up to 60 percent on twenty thousand types of goods imported into the United States. The net effect of the Act was to squash any hope of an economic recovery in the aftermath of the Great Depression and to cut world trade by 33 percent.

In addition, readers might tremble to know that Hoover took office with US equity valuations at very high levels. Robert Shiller’s excellent database highlights that the US market’s price to earnings ratio was at 32 in January 1929 (the highest it reached was 44 in December 1999) and that it reads 29.5 today, which is 75 percent higher than the historical average of 16 and thus puts the market in expensive territory from a valuation standpoint. Eight months into Hoover’s term the Wall Street Crash occurred, and the United States lurched first into recession and then into the Great Depression.

Whenever the market wobbles as it did last week, some investors revisit the ‘Great Depression’ hypothesis, and many others point to a coming recession. For my part I am sticking to my cautious line for a number of reasons.

First the trade war is a reminder of the many policy risks in the world (widespread negative yields are another pointer), and of the fact that as growth slows, countries will squabble more over the crumbling pie of globalization.

Second, moves in other asset classes than equities – government bonds, even corporate and high yield bonds and particularly commodities are bearish

Third, the world is becoming more fractured. South Korea and Japan are locked in a trade dispute, and there is a growing risk of some form of confrontation between India and Pakistan. Do not of course forget events in Hong Kong, and the untethering of the yuan.

With lots to watch, have a great week ahead,

Mike

Diplomacy

Diplomacy in action

An ambassador should be ‘an honest (wo)man sent to lie abroad for the good of his country’ according to Sir Henry Wotton, a seventeenth century British diplomat, writer and politician. It is something of a surprise then that this sage advice was unheeded by the seasoned British diplomat Sir Kim Darroch, lately UK Ambassador to the US.

His failing was to tell the truth about the court of Donald Trump, and even boringly, to be caught stating the obvious. At least, the outgoing, flamboyant French Ambassador to Washington Gerard Araud waited till he had retired to speak his mind (‘unpredictable’, ‘uninformed’, ‘America Alone’).

Darroch’s resignation, in diplomatically unusual circumstances following the President’s decision to boycott him, tells us much about the conduct of diplomacy today, the demise of Britain as a world power and importantly, America’s place in the world today.

Historically, since the foundation of nation states and the rise of the idea of the balance of power, the role of the diplomat emerged in the middle of the 17th century, with Venice as a particular centre of power. Then, diplomats were a mixture of spies, messengers, entertainers and persuaders and many still are today. Comfortingly, commentary on Sir Kim reveals that holding decent parties is still a prerequisite for the job.

A more formal definition of the role of diplomacy comes in Sir Harold Nicholson’s book ‘Diplomacy’ where he pins responsibility for foreign policy on elected governments, and assigns ‘negotiations’ as the preserve of diplomats. In the US today, we might well hold that the foreign policy of the government is very hard to identify while the art of negotiation has become the sole preserve of the President.

In days gone by, the opposite was the case with certain diplomats setting foreign policy and negotiating it. One example that comes to mind having just read George Packer’s excellent book ‘Our Man’ is Richard Holbrooke. The book tracks Holbrooke’s career and illustrates how his ambition and intensity were both his strengths and failings. Holbrooke was far more forceful and cutting in his views than most other diplomats, but in the end his career too was cut short by a President (Obama). There are relatively few characters like Holbrooke in world diplomacy today. Financial crises, social media, cyber espionage and the cult of the political personality have made the job of the diplomat more difficult and arguably more important.

I am biased but one success story of recent years is Irish diplomacy, which was mobilized on the European and world stages in the aftermath of the global financial crisis, and then again more recently in the case of Brexit and is now adding new embassies in countries like Columbia.

The same cannot be said of the State Department which has been denuded of talent and expertise under the current administration, and its budget curtailed to such a degree that it has needed the helping fiscal hand of the Pentagon. Outside the State Department though, there are interesting developments in the ‘science of diplomacy’ notably at Harvard’s Belfer Centre where for example there is now a very interesting Economic Diplomacy Initiative spearheaded by Profs Nicholas Burns and Larry Summers.

I am not sure if ‘divorce through diplomacy’ is on the curriculum at Harvard but the UK could do with some help in the area of geopolitics. To my mind, the resignation of Sir Kim destroys once and for all the notion of the ‘special relationship’ and confirms that what ails Britain is not Brexit per se but a national identity crisis in the contest of a decline in power. Britain and its political class need to urgently open up a debate as to what its place in the world is, and how realistically it can remake and reposition itself diplomatically.

One person whose advise might be worth listening to is Henry Kissinger. At 96 he is still going strong, and while I recognize that some will object to his views, his written work is superb and a great example of pithy, thoughtful writing.

On hearing of Sir Kim’s exit I picked up Kissinger’s book ‘Diplomacy’ and found it remarkable in two respects, one for its foresight (it was written in 1992/93) in international relations, and the other, for the way the values driven American foreign policy that Kissinger described is now being undermined by the current President.

Kissinger wrote that America was the first country to adopt a values based approach to foreign policy and that in this context there were two schools of thought as to how to prosecute this – either America would simply be a beacon of democracy that would inspire others or that it would be an active crusader for democracy abroad. Sadly, that beacon is fading.

Have a great week ahead,

Mike