By Christian Takushi, Macro Economist & Geopolitical Strategist, Zurich – 3 October 2018
In this Fall 2018 those following geopolitical-political trends should pay attention to economic data and financial markets. This week’s breakthrough by Washington with Canada
and Mexico to overhaul NAFTA (USMCA) is likely to have an impact on geopolitics and even in some of the US Mid Terms elections. I don’t want to elaborate on the US Trade and Manufacturing strategies in this report – rather to look forward at how the Political Process is likely to interact with the economy and financial markets as we move closer to 2020. As I’ve said before we might be approaching a period in which I may release more reports to you, because the deviation (or delta) between my analysis and consensus is increasing on many fronts.
Before we zero in on America & markets, here some of the other developments we are watching that are being overlooked by Consensus, but that will matter down the road ..
- Shinzo Abe has won yet another clear mandate to steer Japan further on its traditional conservative nationalist course – With consequences for China and North Korea. Japan is experiencing just the opposite of Germany. While Mrs. Merkel used her long rule to steer Germany to the liberal-center, Mr. Abe is using his long rule to shift Japan to the nationalist-conservative-right. Merkel’s power is fading fast, while Abe’s power is at its height. No other G7 leader has the backing and mandate he currently enjoys. Few in the West are aware of the following: Despite a shrinking labor force, a strong Yen and a tough immigration policy Japan has been growing her GDP per capita as fast as Germany over the last decade. With the difference that Japanese feel very safe and Japan’s big cities rank among the safest in the world. That has handed Abe a strong mandate to keep security as top priority. As we predicted in 2016, just as Seoul is becoming a less reliable ally for Washington (the relationship becoming more asymmetric), Tokyo is rising as a strategic US military ally. One ready to contain China and North Korea more assertively. It is all interconnected: Abe’s mandate should be seen as part of Asia’s response to China’s expansion and Xi’s power grab. Tokyo’s course challenges the EU: Tokyo welcomes multilateral cooperation more than Washington, but it doesn’t trade security and national cohesion for GDP growth hopes. Not long ago, Japanese voters were becoming more open to immigration, but the mass influx of illegal immigrants into Europe reversed that nascent trend.
- The military and economic interests of New Delhi, Tokyo and Washington are converging fast. Just as Beijing’s hegemonic aspirations are beginning to backfire, New Dehli’s cautious Foreign Policy is beginning to pay off. Beijing is not only facing a pushback overseas, even domestically a growing number of Chinese thought leaders worry about the excessively assertive power grab & foreign policy by President Xi. I stick to my forecast that Trade Growth Momentum is likely to shift to the Pacific-Indian Oceans. This is not only due to geopolitics, but also the development of India and Sub-Saharan Africa
Peru‘s President Martin Vizcarra won international and investors’ support for his reform plans to cleanse both Congress and Justice System from corruption via a constitutional referendum. Being Peru a “model economy” with one of the most disciplined Fiscal Policies worldwide, the reforms will be closely watched by investors, allies and foes (i.e. Mercosur) alike. This could be one of the positive triggers that could draw attention back to Emerging Markets. I keep my forecast that Colombia and Peru have the biggest economic potential over the next 20 years in South America. Investors’ infatuation with benchmarks and size has locked them in uncompetitive-protectionist Mercosur: Brazil & Argentina. While Brazil can break out of the past, Argentina is unlikely to embrace market discipline. The IMF has just committed a large aid to Argentina, but I believe it may have to write off most of it. It is impossible for Argentina to currently deliver on fiscal discipline and austerity. This is the by-product of decades under a revolutionary Socialist Populism that shuns fiscal and market disciplines.
- The arrival of the lethal S-300 air defense batteries in Syria are a game changer. My analysis shows something that consensus overlooks: President Putin authorised the move in order to deflect the growing pressure of the Military Leadership and Nationalist Forces on him. They demanded a strike on Israel or NATO. Western governments and think tanks keep reasserting the idea that President Putin is the biggest threat in the East. While Moscow is projecting power and could strike Europe or the USA by surprise, the biggest strategic threat lies elsewhere. Western readers need to know, Putin has more than once held his peace and averted a direct military confrontation. Russia’s military is on edge since the encirclement of Russia by the EU and NATO.
- With the Middle East gearing up for conflict, Israel is understandably highly preoccupied (possibly obsessed) with Teheran and overlooking the real destabilising power up North: Ankara. Teheran and Ankara are amassing fighters and assets (missiles etc.) in Gaza, Lebanon, Syria and Iraq. While Consensus is diametrically opposed to my view, I stick to my forecast that a Peace Treaty between Israel and Palestine over the next 7 years is much more likely than over the past 14 years. Nevertheless, large scale wars in the region are sadly only a matter of time. The coming Peace Treaty will NOT solve most conflicts in the Middle East as so many leaders and experts are saying. The obsession with this Peace Deal is allowing all other conflicts and the related arms races to advance unchecked. I stick to the forecast that Europe and China will be the most affected by the disruptions caused by the coming wars in the Middle East. All world powers (new and old alike) are projecting power over the Middle East and Jerusalem. Such conflictive forces will unravel in the Middle East, allowing the world to enter a new geopolitical equilibrium.
Eyeing America 2020, the economy & markets
At a time when many active investors are short Treasuries and the FED’s guidance implies higher interest rates in 2019, Consensus sees a steady rise of 10 Year yields to roughly 3.5% in 2019. The problem I see is that most investors are extrapolating the past 10 years and seeing too gentle a rise in interest rates over the next 1-2 years. One of my objections is that more than in past cycles, 10 year US Treasury Yield is reflecting both domestic and geopolitical factors. Investors being ill-prepared to assess the latter factor. Ten years of practically zero rates, artificial ultra-low volatility and steady markets have “spoiled” many. That is likely to create important feedback loops on economic and foreign policy as we approach 2020.
Looking ahead to 2020: Lower taxes, less regulation and the political impasse in Washington are a rare mix generating optimism among small & mid-sized businesses in America. For the first time in decades, small firms are enjoying a respite in an otherwise relentless regulatory onslaught that has benefitted big firms. Although oligopolies are detrimental for competition and they influence the political process, their lobbying power has so far shielded them effectively.
What I see is a domestic US economy that is not only doing well, but faces less headwinds than other parts of the global economy (i.e. Europe). I am not talking simply about GDP, which can be trade-data sensitive and detached from Main Street, but about domestic economic optimism. The one that plays a secondary role in 2018, but potentially a big role in 2020. Relying too much on the same data everyone else is watching: When a man begins to dream again of having a small business or moving to a nicer neighborhood, he may actually first reduce spending to save up some capital. Analysts see a dip in retail spending, but something more important happens to this man’s heart. To catch optimism we need to think out of the box.
Should the Democrats do well this November, I see the Trump-Pence team abandoning support for the S&P500 in order to mobilise the working class & middle class. It would shift the battleground maps to the suburbs. What could be a likely move? Challenging or breaking up oligopolies. The side-effect: this would hurt the S&P500, trade data and GDP. It would increase risk premiums on S&P earnings. It is the richest households that own the biggest share of large cap shares. Smaller US businesses seem to have less downside than large multinationals as we approach 2020. Unfortunately for benchmark-oriented investors, after keeping most of the economic rent for themselves, US tech giants have not only defied Berlin and Paris….but also Washington lately. A series of uncomfortable revelations affecting conservative users has aggravated conservative voters. Trump-Pence are likely to clamp down on oligopolies to revive competition, lower prices and reduce big firms’ grip on Washington. They could argue that oligopolies’ influence on the US Political Process is as unhealthy as foreign meddling. The decline in the S&P could be blamed on an obstructionist Congress.
Barring a total sweep for the Democrats in the Mid Terms and a major risk event, I think the US economy should be able to keep up domestic momentum in 2019 better than generally expected by a growing number of analysts. Some big institutional investors – especially in Europe – are saying that the US economy is growing purely on tax-support. A widespread view among many economists and political analysts that could backfire. While partly correct, there is more happening in the US suburbs and rural counties than just tax-support.
I also believe many investors will read too much into both inflation (a lagging indicator) and the shape of the Yield Curve over the next 12 months. We should not rule out that a phase of higher short rates and geopolitically induced higher demand for Treasuries (downward pressure on the 10 Year Yield) could overlap. That could be mis-interpreted as an inverse Yield Curve over the next 12 months. Economic and investment models are likely to mislead investors. Despite the challenges, America is in a resurgent mode: it is increasingly using all the tools and capabilities at its disposition.
Christian Takushi MA UZH, Macro Economist & Geopolitical Strategist, Zurich – 3 October 2018
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(a) All nations & groups advance their geostrategic interests with all the means at their disposal
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