Wielding geoeconomic tools with success

Beyond sheer size, sums, and growth rates, four more variables help explain a country’s ability to translate its domestic market into geopolitical leverage:

ability to exercise uniquely tight rein over access to domestic markets,

capacity to redirect domestic import appetites to make a geopolitical point,

actual or perceived consensus that a country’s domestic market is too large to ignore (this, of course, especially applies to China and is merely a regional dynamic in the case of Russia), and

a growth trajectory that makes other countries see rising future costs to opposing its foreign policy interests today. Of the various geoeconomic instruments currently in use, these domestic market features are probably most relevant in determining how fruitful particular trade and investment policy and sanctions efforts will be in producing geopolitical benefits.

That is a great framework to think of international trade in geoeconomic terms.  It is from the book, ‘War by other means’ by Robert Blackwill and Jennifer Harris. I have finished reading five of the ten chapters of the book. I found it rich in terms of information. The geoeconomic strategies and tactics adopted by Russia and China are extremely interesting and useful.

I was pleased to note that the authors confirm my understanding of geoeconomics: the use of economics as a tool to further the nation-state’s geopolitical and international power projection goals and not the other way around.

In general,the authors note that China has scored tangible gains – at least in the near term – from their application of geoeconomics as a weapon/tool to achieve their goals. This is what they write:

China openly flexes geoeconomic muscle—both positive and negative—and much of the time it succeeds in advancing Chinese geopolitical interests, at least to some degree, on issues of concern to it. This is not to suggest that China’s geoeconomic tactics are always efficient, in either economic or geopolitical terms, or that there are not cases of overreach and backfire. But by exercising this pressure China has managed to deter arms sales to Taipei and to steadily reduce the number of countries to recognize Taiwan; it has curtailed the activities of the Dalai Lama; it has deterred countries from political showings of support for human rights issues; it has registered noticeable impacts on votes in the UN and frustrated various Western efforts to pressure North Korea; it has given tactical support to a newly emboldened Russian foreign policy; and, not least, it has challenged the balance of power in Southeast Asia, forcing some countries to alter course in pursuing territorial claims, and placing others on notice.

In that sense, what President Trump has been doing in his seven months is to bring back geoeconomics to American foreign policy which, the authors say, America has grown out of. My guess is that, in principle, the authors might approve of what the Trump administration is doing.

In that context, read what Professor Graham Allison had written in the Wall Street Journal on the President’s handling of North Korea. He seems to find a logic in the seeming irrationality. In fact, that is the very idea.

Also, recall what William Galston wrote on August 9 in WSJ on technology transfers and China:

If turning over our technological crown jewels to a foreign power is against the national interest, then our government should have the power to prevent it. But wielding this power without blowing up the international trade regime will not be easy. [Link]

In other words, it is not easy dealing with someone who thinks they obey only the rules they make. Of course, today’s superpowers behaved the same way when they were rising powers.  Now that they are status quo powers, the aspiring powers would challenge the order that they established. So, both the US and China are doing what they are expected to do. But, from the American point of view, confronting the challenge of China would not be easy and criticising the approach of the Trump administration is easier than coming up with more feasible alternatives.

Chinese reactions show that they are worried by the U.S. announcing an investigation into the theft of intellectual property by Chinese firms. The investigations could pave the way for retaliatory action by the United States. See here and here. China says that the American actions threaten to blow up the global trading system but that is what is needed, according to William Galston, to stop China’s ‘unfair trade practices’.

One final point: we should not forget that China’s domestic economic vulnerabilities have risen in tandem with its ability, willingness and brazenness in wielding geoeconomic tools. Perhaps, there is a causation from the former to the latter? I am yet to read the latest IMF Article IV Annual Economic Assessment of the Chinese economy and ‘Selected Issues’. I understand that the Fund has been rather forthright in its bleak assessment of the Chinese economy risks.


The Philips Curve

Just came across a headline that linked to an article in Bloomberg on the failure of the Philips curve to predict inflation.  The article, in turn, was based on a new study by the Federal Reserve Bank of Philadelphia. The chart that the Bloomberg article features is this:

Bloomberg_Unemployment and inflation rate_24082017

One look at the chart confirms the following sentences found in the Bloomberg article:

The Philadelphia Fed economists found that rising unemployment was sometimes able to help predict lower inflation, but falling unemployment didn’t help predict higher inflation. They noted that was particularly the case during the 1970s and early 1980s when the Fed responded to runaway inflation by raising rates so high that the U.S. economy fell into recession. [Link]

As one sees the chart carefully, one notices that the inverse relationship between the two lines (blue and white) has broken down in two periods: in the Nineties and in the post-2008 crisis period. The relationship between the unemployment rate and the inflation rate shown in the chart (the PCE inflation rate) had broken down because falling unemployment rate did not trigger higher wages for workers. There are many reasons for it and this blog post alone cannot do justice to them. One catch-all answer was that the 1990s was a period of globalisation that expanded the global pool of labour and hence, wage growth was muted despite the falling unemployment rate.

Post-crisis, the worker uncertainty was high and the unemployment rate remained in double digits in the US until about mid-2010. Its slow descent did not really cause wages to rise, especially since the jobs that replaced the jobs lost were long hours-low pay jobs. Towards the tail end of this period, wages could have risen as globalisation came to a halt. But now, there is another uncertainty for workers – technology.

In short, the failure of the Philips curve to hold over time or the weakening of the relationship posited by the Philips curve could and should be traced to trade, technology and inequality.

The full paper is here.

President Trump and contrarian instincts

I shared the chart that came with this tweet. Of course, it is highly misleading and it can also be wrong. For example, President Obama took office while the 2008 financial crisis was winding its way down. Hence, volatility in stock markets was to be expected.

A friend took exception to my sharing this chart and thought that I was defending President Trump more than warranted. That gave me an opportunity to explain my stance one more time and not for the last time, of course. I wrote these following points in an email and they reflect no particular prioritisation.  I reproduce the points below with very slight modifications and with some links too.

(1) American voters did not have good choices in Nov. 2016

(2) If Hillary or Bernie had won, much of the damage to the underlying system would be insidious and not apparent.

(3) If Trump were elected, I thought that democracy would be better served for the media and civil society would watch over him like a hawk.  The last seven months have proven me right. In fact, too right. That is part of the problem. It would not have happened with (2) above.

(4) There is far greater illiberalism and intolerance in Xi’s China than in Trump’s America. In fact, the sheer spite and venom that Trump is getting is proof that none has been suppressed. Media is not remotely as ruthless with China as they are with Trump.

The latest Cambridge University Press episode is just but the latest. The open letter by Professor James Milward of Georgetown University asks the right question: Had the same ‘request’ gone from the Trump administration to CUP, how would the academia and the media have reacted?

(5) Small businesses are feeling a lot more confident now than they ever did in the last eight years. No Mainstream Media (MSM) coverage.

(6) If America had to elect Trump in 2016, then what must have transpired for things to come to such a pass? Who are responsible? Obama, Bernanke, Greenspan, Paulson, Geithner, Summers, et al? No introspection on their part nor critical examination on the part of outsiders. Instead, they are being acclaimed and put on a pedestal. The insanity, irrationality and the hypocrisy of it all is breathtaking.

(7) I look for arguments to being a contrarian. That goes with my predilection to be a value investor/strategist in the market with all its deficiencies and strengths. For the most part, consensus must be already in the price and discounted. There is not purchase left in joining the consensus. This instinct – with all its strengths and weaknesses – honed in the two decades of being an investment strategist informs my attitude to many other things too.

(8) I have also written that the individual Trump is the enemy of President Trump. He has too many flaws to be effective as a President. Forget about being role models for children. Being effective as a President matters and that is being undermined by his tendency to pick too many small battles as well. President Reagan had a terrific sense of humour too. That helped disarm many. But, Trump does not seem to possess that skill.

(9) Finally, and this is a good thing, his Presidency is bringing to the surface, into the open, all the underlying schisms and fault lines in the American society including the dangerously unsustainable political correctness, instead of being suppressed.  Amidst all the chaos, serious minds are focusing on the illiberalism of the liberals, the rise of the extreme right, the plight of the white middle class male, the Opium crisis, etc. The Google episode (the outing of James Damore) is a manifestation of this. America might emerge at the end of this churn. In a way, Trump Presidency is facilitating it and paving the way for it.

The meaning of the week for the American President

The incidents at Charlottesville and the seeming flip-flop of the American President have been the issues that dominate the public airwaves in the US, notwithstanding another terrorist incident in the world, this time in Barcelona. Coverage of it has been surprisingly muted or may be, I did not look in the right places.

It should not have been too difficult to condemn white supremacists and neo-Nazis even if one had sympathies for the underlying feelings of disempowerment that middle-aged or elderly white males were experiencing. These are sensitive issues and one has to be good at nuanced communications separating one emotion from the other. Thus far, the President had not given much inclination of indication of his capabilities for nuanced expressions. A somewhat dated piece (last month!) by Peggy Noonan in the Wall Street Journal is a very good read.

At the same time, it is rational for politicians to do their electoral calculations in their heads and figure out how far they would be alienating their core constituencies. Many other political leaders, over the years, in democratic societies have equivocated in verbalising their own disapproval or angst over specific conduct. What is important is whether the country allows such forces to get away with it. There is very little to fear on that score. In the case of the U.S, that has not and does not stand in the way of the pursuit of the matter as law and order is in the hands of the State and they are going about it.

Rather separately, on the underlying issue of Confederacy statues, this Wall Street Journal article pointed to a NPR/PBS poll:

An NPR/PBS NewsHour/Marist Poll finds that even a survey sample that gives Mr. Trump his standard lousy approval rating overwhelmingly agrees with the President that statues of Confederate leaders should not be torn down. Even a plurality of African-Americans agrees that the statues should remain in place as symbols of our history. [Link]

I checked out the poll directly. This is the question that was posed to the survey respondents:

Do you think statues honouring leaders of the Confederacy should

Remain as a historical symbol?

Should be removed because they are offensive to some people?


You can see the survey results yourself here or here. Once again, as Mark Lilla had written (extracted his from his book) here, the hyper-ventilation of the so-called elites and the media types is out of touch with the reality and the opinions of the people on the issue of Confederacy statues:

It is time to admit that American liberalism is in deep crisis: a crisis of imagination and ambition on our side, a crisis of attachment and trust on the side of the wider public. The question is, why? Why would those who claim to speak for and defend the great American demos be so indifferent to stirring its feelings and gaining its trust? Why, in the contest for the American imagination, have liberals simply abdicated?….. [Link]

Of course, the elites and the media types are not dumb. Why are they doing it? Two reasons, as I can see:

(1) They have to avenge the humiliation of not having been able to stop Trump from becoming their President in 2016.

(2) Two, they do not want to repeat the mistake of 2016 in 2020. They have to stop him right now. So, they are employing all tactics possible. Breaking up his core constituency, creating alienation between him and them, try and impeach him or get him to resign. Whatever. It is shock and awe. Just like banks are ‘too big to fail’, he is ‘too big to be allowed to be re-elected’.

On the economic front, check out this news snippet:

Reuters reviewed NFIB’s data and brought attention to the record number of small business owners that are planning to create jobs in July, which hit a seasonally adjusted net 19 percent that hasn’t been achieved since December 1999. [Link – this link will not be the same next month as it is updated every month]

NFIB stands for the National Federation of Independent Businesses.

Also, check out the Greg Ip article in Wall Street Journal here. The title of the article captures it all.

Six months into his presidency, Donald Trump’s detractors portray him as a do-nothing president with no big wins on issues such as health care, taxes and infrastructure.

That may be true if the benchmark is legislation, but that is an incomplete benchmark. To gauge a president’s impact you have to go beyond the laws he signs to the vast authority he wields through departments and agencies that apply the law. On that score, Mr. Trump is on track to do a lot. On finance, the internet, immigration and drugs, to name just a few issues, Trump appointees have begun nudging the economy and the country in a more conservative, pro-business direction. Whether that is good or bad is to a great extent in the eye of the beholder. What isn’t debatable is that the imperial presidency, after expanding under Barack Obama, remains just as formidable under Mr. Trump.

The American mainstream media has no time nor inclination to report this. They are drowning these news out. See the above two reasons as to why they are doing so.

To be clear, I am not in favour of all the de-regulation that is happening – on bankers’ compensation or dismantling Dodd-Frank without a proper debate (two wrongs do not make a right), etc. With respect to financial markets and the financial sector, I am more on the side of Elizabeth Warren than on the side of Donald Trump’s cabinet. But, if they manage to prescribe a simple but higher bank equity to bank assets ratio, they will have done far better than the Obama Administration did on fixing ‘Too Big to Fail’.

Of course, then there are issues of corporate executive compensation, Wall Street’s short-term tendencies, monetary policy obsession with asset markets, particularly stock markets. On these matters, perhaps, the Trump administration is on the wrong side of the debate, in my  view. In fact, the hope was that, at least on some of them, they would be on the right side (e.g., monetary policy). But, those hopes are receding.

Not that all de-regulation is for the good. I have also told my class that the world of finance and the world of non-financial sectors are different.

But, perhaps, the final word has to rest with an article in India’s ‘Swarajya’ magazine. There is no byline for the article.

Alternatively or even better, I would recommend Amy Zegart’s article in ‘The Atlantic’. The article is titled, ‘The Three Paradoxes Disrupting American Politics’ and the sub-title is ‘They didn’t start with Trump, and they won’t end with him.’. Quite.

Trump may personify America’s descent into coarse discourse and amplify its spread. But it didn’t start and will not stop in Trump Tower or the White House. The root causes lie deeper.

A reaction to Swadeshi vs. Videshi

In response to remarks made by Rajiv Kumar, the new Vice-Chairman designate of NITI-Aayog on the ‘Indian way of doing economics’  (I am paraphrasing and simplifying, perhaps oversimplifying), I had written a piece in MINT asking for open-mindedness rather than meeting with ideological rigidity and arrogance with a similar response. You can read it here.

A friend living outside of India reacted. I thought it was interesting. Somewhat unsurprisingly, he prefers to remain unnamed on this:

This foreign stuff is petty nonsense and RK has a Oxford D.Phil. The alleged Sangh dislike of the foreign stems from a mixture of envy and admiration. I used to get phone calls regularly to assist in the admission of children and relatives of successful Sangh functionaries at my University. They couldn’t understand why I insisted it could not be influenced in this way!

As for foreign influence, most of the profoundly nativist convictions of the Sangh (and most Indians) are presumptions infused by colonial bureaucrats like Max Mueller and others of much less distinction.

If you want to exclude foreign influence one should start with the Cambridge educated Aurobindo and also recall Vivekananda’s fame in India came via his Chicago address.

By all means, be sceptical but also remain open minded. Much of what originates abroad, especially on things like the efficient market hypothesis and the functioning of financial markets is suspect (Anwar Shaikh is damn good on this) but one should not abandon immanent logic itself. Ignorance cannot be obscured by huffing and puffing stupidly to advance personal and career aspirations masquerading as patriotism.

ECB Meeting Minutes

The Minutes of the European Central Bank (ECB) meeting held in the first week of August were released on August 17. Members had expressed concern over the strength of the Euro, overshooting further.[1] That was a surprise. One thought that Germany would tolerate a stronger Euro in return for less pressure on its high current account surplus. Further, even for other countries (the Southern European or peripheral countries), the real effective exchange rate is not overvalued. The Eurozone enjoys a current account surplus, even if modest. Not just Germany.

Instead, the ECB Governing Council was worried that the strength of the Euro would undermine its progress towards a 2% inflation rate, from below.

In fact, the Minutes reiterated the need for continued monetary policy accommodation more than once. It stressed that interest rates could remain at the present levels well past the end of the asset purchase programme:

The Governing Council decided to keep the interest rates on the Eurosystem’s main refinancing operations, the marginal lending facility and the deposit facility unchanged at 0.00%, 0.25% and ‑0.40% respectively. The Governing Council expected the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases. [Link]

Vague concerns were expressed about the low volatility in financial markets. Other than that, the ECB Governing Council had nothing to say about its monetary policy distorting global asset prices. Not just the Euro, but the ECB monetary policy is another bubble that needs to burst for the world to return to normalcy.

They should read what Howard Marks had written about the low volatility in his recent newsletter. [Page 5 – Link]

Thoughts on the latest GMO Asset class return forecast

I got GMO’s July 2017 update of Return Expectation over the next seven years. This form the basis of their asset allocation. You just need to set up a simple login to see their Asset Class Return forecasts.

The best way to read it is to compare it with their forecasts in recent months. I have compared it to May and March 2017.

U.S. large cap stocks, U.S. High Quality Stocks, International Large cap stocks, Emerging stocks and emerging debt have all become more overpriced in the last few months. Hence, GMO forecast of returns from these asset classes has become progressively lower over the months.

If we compare it to the situation in August 2016 – one year ago – Emerging market bonds and U.S. bonds have become somewhat less overvalued. That is, the return expectations from these two asset classes have improved in the last twelve months.

However, please note that the return expectations are still negative in the case of U.S. bonds. So, according to their model, it is still overvalued but somewhat less so than in August 2016.