The Trump Trade War Recession?

By John Mauldin

 TFTF Image

“A conservative is someone who stands athwart history, yelling stop, at a time when no one is inclined to do so, or to have much patience with those who so urge it.”

 

 
 
I will never compare myself to Bill Buckley, as a writer or anything else. He was one-of-a-kind and a personal hero who I am disappointed to say I never met but who I read a lot. The response to my recent tariff comments gives me a small hint of how it must have felt to “stand athwart history” and launch the modern conservative movement. Many of you support the tariffs.

And I understand your reasons. I really do.
 
Free trade used to be a core belief of the conservative movement. Hayek, Friedman, Mises, Rothbard, and numerous other economists eloquently explained why. Several liberal economists agree. Conservative politicians spent the last few decades moving us in that direction, albeit imperfectly and with some big mistakes along the way. But few disagreed with the ideal.
 
Let me be clear on this: I do not think the tariffs on China are going to cause a recession. But if we have a recession, that is precisely what the Democrats will say. Democrats will not run against the Fed, investor sentiment, markets, Italy, or anything else that actually causes the next recession. They will be running against Trump and everything will be his fault. It will be the Trump Trade War Recession. Whether or not it is true is immaterial.
 
That is neither here or there because a trade war with China introduces too many variables into an already difficult situation. Let’s look at what is actually happening on the ground.

Hoover, Smoot & Hawley
 
We all wonder if Trump’s trade actions are as random as they appear or if there is a broader strategy. Some of my contacts argue that the relatively strong US economy allows the administration to take a harder line than would normally be advisable. We can ride out a trade war better than China can, the thinking goes.
 
This only works if the US economy keeps prospering long enough for the tariffs to make China bend. We can postpone a recession for another year or two if the trade war doesn’t intensify and Europe holds together. Since it is intensifying—with a new round of 10% tariffs taking effect this week and more to come in January—we may not get that time.
 
In other words, tariffs could end the conditions that justified them. Something similar happened before, during the most famous trade mistake in US and global history: the 1930s Smoot-Hawley tariffs.
 
Similar to today, the Roaring 1920s saw rapid technological change, specifically automobiles and electricity. This created a farm surplus as fewer horses consumed less feed. Prices fell and farmers complained of foreign competition. Herbert Hoover promised higher tariffs in his 1928 presidential campaign. He won, and the House passed a tariff bill in May 1929.
 
The Senate was still debating its version of the bill when the stock market crashed in October 1929. Today, we use that event to mark the Great Depression’s beginning, but at the time, people didn’t know they were in a depression or even a recession. Most economists expected a quick recovery. Stocks did recover quite a bit in the following months, though not back to their prior highs.
 
So, when the Senate finally passed a tariff bill in March 1930, the thinking was not that different than we see today. They thought they could preserve and even extend the good times. But conditions worsened quickly and by 1931, unemployed men were standing in soup lines.
 
 
In 1932, both Smoot and Hawley lost their seats as Franklin Roosevelt beat Hoover in a landslide—57% of the popular vote. That history won’t necessarily repeat this time, but it’s surely not a good omen.
 
 
John Nash (one of the world’s great mathematicians, Nobel laureate, and centerpiece of the brilliant movie A Beautiful Mind) developed multiplayer game theory. Essentially, an equilibrium develops around the rules as they are at the moment. If somebody changes the rules, no matter how rational the rule change may seem to be to the person who’s making the change, it makes everybody else change their response.
 

Trump’s actions, especially in regard to China, may be perfectly rational. China is not playing fairly. But his actions change the rules and everybody else is forced to react.
 

Throw in NAFTA, Europe, and all the other trade negotiations, and things get complicated. Yes, we have a new trade deal with Korea. The US is marginally better off. Trump is trying to do a one-off trade deal with Japan. Abe is cautious because Trump wants to open up Japan’s markets to US agriculture.
 
We pulled out of the Trans Pacific Partnership (TPP) because it had flaws—clearly. But it served the purpose of isolating China.
 
Trying to do bilateral trade agreements with every one of those partners is going to be extraordinarily difficult and time-consuming, if not impossible. And so, everybody reacts to try to change the circumstances to their own Benefit.
 

This is multiplayer game theory on a scale so vast that it is almost impossible for a human being sitting in the middle of the United States working at his job, just trying to get through the day, to understand. And so, they get angry and say we need more tariffs to protect America. Just like every other voter in every other country is trying to figure out how to protect their markets.

Trade Sandpile

Something else I keep hearing is variations of, “China is cheating, and we have to do something.” This comment from reader Justin McCarthy is typical.
 
I get all the handwringing and pearl clutching about trade wars. But it really appears that true free and fair trade is an illusion. China cheats. Why? Because it can. Everyone pretty much acknowledges it. But where are the projections and analyses of the long-term consequences of permitting the status quo to continue? What are the consequences of letting the balance of power shift in China's favor? I see a lot of angst about trade wars but no discussion about the effects of no action.
 
 
Justin said this nicely, but I have to disagree. He’s right that “true free and fair trade” is not what we have, nor have ever had. But trade isn’t a binary condition. Today, we see near-total isolation on one extreme (think North Korea) or at the other end extensive trade freedom, as nominally exists within the European Union. There’s lots of room in between.
 
China cheats in many and various ways, which I have stated are problematic. I’m not happy with the status quo, and I want to change it. The question is, are tariffs the best way to accomplish this? A second question is, even if tariffs accomplish the goal, will there be side effects that reduce or eliminate the benefits? I see a lot of unintended consequences.
 
A few weeks ago, I described how a sandpile can slowly grow in size, apparently stable, but in reality, it has many hidden fingers of instability. At any moment, something could trigger an avalanche.
 
The global trade system is something like that. Of course, it’s not perfect or even optimal. Countries erect barriers to their advantage. I can point to several countries whose economic policies are mercantilist, but at least everyone knows about them. We see the fingers of instability and leave them alone, lest we trigger an avalanche whose victims are impossible to predict. It is a kind of equilibrium.

Everyone’s incentive is to avoid catastrophe and make incremental improvements. That makes trade talks extraordinarily difficult.
 
The Trump administration doesn’t seem to care about equilibrium. Whether the president himself or those around him, the strategy appears to be “kick apart the sandpile and make everybody rebuild it.” And whether we like it or not, many of Trump supporters actually like the concept of throwing a wrench into the system.
 
So, it is not the case that the US has no choices. We have many choices. Tariffs are the wrong one. But then, that is just me and I am one lone voice and vote.

Victim List

Commerce Secretary Wilbur Ross is a brilliant businessman. He is proving less than effective as a public advocate for administration policy. Earlier this month, he appeared on CNBC to tell us the latest tariffs won’t be so bad.
 

Source: CNBC

Commerce Secretary Wilbur Ross concedes that prices in the US will increase as a result of the new China tariffs put in place by President Donald Trump.
 
However, Ross told CNBC on Tuesday, “Nobody is going to actually notice it at the end of the day,” because the hikes will be “spread across thousands and thousands of products.”
 
“If you have a 10 percent tariff on another $200 billion, that’s $20 billion a year. That’s a tiny, tiny, tiny fraction of 1 percent [of] inflation in the US,” Ross said.

 
That last part is true. Direct tariff impact will be a tiny part of overall inflation. But it’s wrong to say no one will notice. Plenty of people and businesses are already noticing. And when those tariffs go to 25% in a few months, $20 billion becomes $50 billion. That will be felt by the Walmart nation, and a long list of US corporations.
 
Cato Institute trade scholar Scott Lincicome assembled a handy list for Reason magazine. It includes 202 companies with links to local news stories that describe how tariffs hurt them. Some are large, some small. This example from the metal industry: The New Hampshire metal-service center has been forced to turn down large orders from potential customers because it can’t source material due to tariffs.
 
Browse the full list with source links here. Remove sharp objects from your vicinity when you do. The impact seems minor in many cases, but they add up. They spread, too: All these companies have customers and suppliers who depend on them. And we’re not even talking about the farmers who are already being hit with lower prices and higher costs. Think fingers of instability and sand piles.
 
Some people say that the service sector is 85% of the economy, so tariffs can’t do that much damage. Much of that service sector serves people who manufacture stuff, buy food, and go to restaurants. It’s that sandpile thing again.
 
The weirdest part is that tariffs could drive some of these companies to move production outside of the US. That’s the opposite of what we want. We already see it with Harley-Davidson, which is going to make motorcycles for the European market in a third country, thereby avoiding the retaliatory EU tariffs that would apply were they made in the US. Business-wise, that’s the smartest move Harley can make. But it will hurt US workers, not help them.

Lopsided Polls


Now, I can argue against tariffs until I turn blue, but I doubt it will have much effect. Yes, I voted Republican and that party controls both the White House and Congress. But I now find that I am in the minority. I am literally standing athwart my party yelling, “Stop.”
 
A recent New York Times poll found that 79% of Republicans favor tariffs.

Dear gods, have we come to this? In this graph, 73% of Republicans favor both tariffs and tax cuts while 6% oppose tax cuts and favor tariffs. I keep talking to more and more of my friends, nominally Republican, and we agree that we no longer have a party that represents us. Certainly, the Democrats don’t. I’ve shown the data in the last few weeks that independents are an increasingly small minority. When 79% of Republicans favor tariffs, and 80% of Democrats oppose tariffs, the world has truly turned upside down.

 


So where is this going? Barring some titanic shift in the midterms, the president will stay on course and Congress won’t stop him. We should know in the next week or two what happens with NAFTA. Trump has a meeting with Xi in late November.
 
My sources in China believe that something will happen to stall off the major effects of tariffs. But if Trump is looking for Xi to capitulate or somehow lose face, he is going to be waiting forever. Xi will use it to his favor.
 
Further, China is growing their exports to other nations so fast that they can replace whatever they might lose to the US within a few years. Trump may think that China needs us, and to some extent they do, but we need them as well. The world works much better when everybody works together.

Investors in the Hands of an Angry Market

For sins in many of my past lives, I have a seminary degree. One of the things we learned about was the First Great Awakening. The most famous sermon of that time was by Jonathan Edwards in 1741. Part of his fire and brimstone rhetoric, which today I find depressing, was the line, “…God that holds you over the pit of hell, much as one holds a spider or some loathsome insect over the fire…”
 
While I do not believe that investors will fall into some fiery pit, I do believe that investors, especially those that are of the buy-and-hold bent, are held by a spider thread over a potentially angry market.
 
A few quick charts and points. These first two charts are from Dr. Vikram Mansharamani, a good friend who is now teaching at Harvard. Basically, global mining stocks to the NASDAQ 100 is roughly back to where it was in 1999. If you own commodities, you’ve been getting your head handed to you. The second chart shows what the S&P would look like without technology stocks in them, which is to say they would be down.
 

Source: Dr. Vikram Mansharamani

Source: Dr. Vikram Mansharamani

Technology stocks, with high P/E ratios, are driving this market. Kind of like 1999.
 
Next up, a few charts from Sam Rines. The first is the famous dot plot. Note that the median Federal Reserve member plans to hike interest rates by one full percent between now and the end of 2019. It is clear that they intend to hike another 25 basis points in December. And several members have been making speeches claiming that an inverted yield curve doesn’t mean anything. Evidently Chairman Powell is of the same mind.
 

Source: Sam Rines
 
Let’s look at the yield curve. Notice it is getting flatter towards the higher end and as Sam points out, there is only three basis points difference between the seven- and ten-year bonds. A full 1% increase would invert the yield curve.
 

Source: Sam Rines


True story: In late 2006, I called the Federal Reserve economist who did the study noting that the only reliable indicator out of 20 potential indicators of a future recession was an inverted yield curve. The yield curve was inverted at that time, and I asked him what that meant. I swear to God, he said, “I don’t think it means we will have a recession this time.” And he then went on to explain why.
 
He was wrong. In writing circles, that is known as an understatement. (Duke Professor Campbell Harvey had done the same study years earlier, and it was well known that an inverted yield curve has always preceded recessions in the US.)

The Seven-Body Problem

For mathematicians, it is well-known that if you have three large objects which have gravitational impact on each other, you can determine where they have been in the past, but you cannot predict where they will be in the future. It is called the Three-Body Problem. We are well beyond the three-body problem in economics.
 
The Federal Reserve is raising rates while selling off $600 billion of Treasuries annually. The ECB and Bank of Japan are reducing their quantitative easing and the ECB may very well stop. God knows what’s happening in Italy. If the dollar doesn’t weaken significantly, emerging markets are in real trouble paying their debt. We are running massive deficits in the US and elsewhere in the developed world, and new technologies are putting old companies at risk.
 
 I can just keep going on and on.
 
If central banks lose what Ben Hunt calls “the narrative,” then it is all over but the shouting. Right now, in central banks we trust. And in my opinion, the Federal Reserve is making a massive mistake in both raising rates and reducing their balance sheets at the same time. They’re going to lose control of the narrative.
 
We’re going to see quantitative easing in our future on a scale that will shock everybody.
 
Remember that I said it. You heard it here first.
 
We have at least a seven-body problem, and there is no way to predict what will happen. And Trump throws in the uncertainty of tariffs and a trade war with China.

He does this at a time when optimism on whatever index you want to look at is at an all-time high, unemployment is low, the economy is booming, and with Republicans hanging on by a bare margin with elections coming up, he could lose his ability to do or pass anything for the next two years.
 
Not unlike 1929. You better have your hedges and strategy together.

There is no reason for the US to go into recession unless a trade war begins to really impact the economy. It doesn’t have to impact a lot in order for future expansion plans by businesses to be impacted.
 
I am getting nervous.
 
Your wondering when we get back to some kind of centrist consensus analyst,
 

 
John Mauldin
Chairman, Mauldin Economics
 


The next financial crisis won’t come from a ‘known unknown’

It is the unexpected interaction of different forces that can be dangerous in the financial system

Robin Wigglesworth


Sir Isaac Newton’s misfortune following his decision to sell shares in the South Sea Company in 1720 shows how even history’s most brilliant minds can fail to spot financial excess © Getty


Almost 300 years ago, one of the smartest ever humans did something very stupid.

In the spring of 1720 Sir Isaac Newton ditched his shares in the South Sea Company, which had been a granted a monopoly on British trade with South America, for a cool 100 per cent profit of £7,000. However, the stock kept climbing and Sir Isaac bought them back at almost three times the price he initially paid. Within months the bubble had burst, obliterating the scientist’s life savings and leading him to lament that he “could calculate the motions of the heavenly bodies but not the madness of people”.

With the 10th anniversary of the global financial crisis approaching, it is natural to attempt to guess where the next debacle will occur. Sir Isaac’s misfortune shows how even history’s most brilliant minds can fail to spot financial excess — aside from his scientific renown, he was also head of the Royal Mint at the time of the South Sea Bubble.

There are of course exceptions, but most prophets are usually little more than professional doomsayers, forever warning of a crash and claiming clairvoyance when one eventually occurs — much like a broken watch is right twice a day. It is also important to remember that crises of the scale of 2008-09 are exceptionally rare.

Some contenders seem obvious: Countries and companies have continued to pile on more debt, and central banks are beginning to withdraw their monetary stimulus. China’s economic slowdown could accelerate into a collapse. European politics still looks risky. Trade tensions might escalate into a full global trade war.

But these are all “known unknowns”, and true financial shocks tend to be something unforeseen, caused by disparate factors interacting in unpredictable ways, and exacerbated because of siloed understanding.

Think of the last crisis. Property experts could see there was a housing bubble — in fact prices peaked in 2006, well before the crisis erupted. But they didn’t appreciate how securitisation had revolutionised the loan market. Bankers and investors didn’t know — or care — how far underwriting standards had eroded, while policymakers were blind to how the financial economy could rip through the real one.

That is natural. The global economy is what scientists call a “complex system”, like a human brain, the ecosystem of the jungle, a nuclear plant or the entire physical universe. In fact, by directly or indirectly linking together every human on the planet in one network the economy is arguably the biggest and most intricate complex system we know about outside the world of physics.

But complex systems are hard to understand, and are inherently fragile. A series of small idiosyncratic failures can interact with each other and cascade into a catastrophe. For example, the Three Mile Island nuclear disaster in 1979 was caused by dodgy plumbing, a stuck valve and an ambiguous indicator light. So where are the dodgy valves, flickering indicators and blocked plumbing of the financial markets today?

To me, the most likely answer lies in the interaction between post-crisis regulation, tectonic shifts in the investment landscape, increasingly fragmented market infrastructure and the rise of algorithmic, automated trading strategies. In isolation, these are mostly positive developments, but combined they make markets more complex — and therefore dangerous.

Trillions of dollars have flowed from traditional mutual funds to passive ones like ETFs since the financial crisis. Trading is being stretched across an increasing number of competing venues. Banks have retreated from markets, to be replaced by tech-savvy but thinly-capitalised trading outfits. Citadel Securities alone accounts for one in every six trades in the US stock market, and other high-frequency traders account for another two.

Meanwhile, computer-powered “ quantitative” investors are ascendant, and increasingly set the tone for markets. Indeed, JPMorgan estimates that HFT, quants, passive funds and options now account for about 90 per cent of all US trading volumes. This trend is already advanced in the equity markets but is spreading in the fixed income universe as well. Glitches are already becoming more common, and a disastrous one looks inevitable.

It is always tempting to be Luddite and think that everything was better before. But that is the wrong response. This is no call to roll back post-crisis regulations, to undo the very real price improvements brought by high-frequency traders, or a denial of the huge savings brought by the passive investing revolution. Those are all genuine improvements.

The danger is in how these tectonic trends may rub against each other. It is hard to see this causing a 2008-style cataclysm, and any economic impact would probably be modest. But of all the potential financial earthquakes lurking out there, this is the least-appreciated.


Has finance been fixed?

The world has not learned the lessons of the financial crisis

Banks are safer, but too much of what has gone wrong since 2008 could happen again




WHEN historians gaze back at the early 21st century, they will identify two seismic shocks. The first was the terrorist attacks of September 11th 2001, the second the global financial crisis, which boiled over ten years ago this month with the collapse of Lehman Brothers. September 11th led to wars, Lehman’s bankruptcy to an economic and political reckoning. Just as the fighting continues, so the reckoning is far from over.

Lehman failed after losing money on toxic loans and securities linked to America’s property market. Its bankruptcy unleashed chaos. Trade fell in every country on which the World Trade Organisation reports. Credit supplied to the real economy fell, by perhaps $2trn in America alone. To limit their indebtedness, governments resorted to austerity. Having exhausted the scope to cut interest rates, central bankers turned to quantitative easing (creating money to buy bonds).

Just as the causes of the financial crisis were many and varied, so were its consequences. It turbocharged today’s populist surge, raising questions about income inequality, job insecurity and globalisation. But it also changed the financial system. The question is: did it change it enough?

To splurge is human

One way—the wrong way—to judge progress would be to expect an end to financial crises. Systemic banking meltdowns are a feature of human history. The IMF has counted 124 of them between 1970 and 2007. There is no question that they will occur again, if only because good times breed complacency. Consider that the Trump administration is deregulating finance during an economic boom and that the Federal Reserve has not yet raised counter-cyclical capital requirements. Even when prudence prevails, no regulator is a perfect judge of risk.

A better test is whether the likelihood and size of crises can be reduced. On that, the news is both good and bad.

First, the good. Banks must now fund themselves with more equity and less debt. They depend less on trading to make money and on short-term wholesale borrowing to finance their activities. Even in Europe, where few banks make large profits, the system as a whole is stronger than it was. Regulators have beefed up their oversight, especially of the largest institutions that are too big to fail. On both sides of the Atlantic banks are subject to regular stress tests and must submit plans for their own orderly demise. Derivatives markets of the type that felled AIG, an insurer, are smaller and safer. Revamped pay policies should prevent a repeat of the injustice of bankers taking public money while pocketing huge pay-packets—in 2009 staff at the five biggest banks trousered $114bn.

Yet many lessons have gone unlearned. Take, for example, policymakers’ mistakes in the aftermath of the crisis. The state had no choice but to stand behind failing banks, but it took the ill-judged decision to all but abandon insolvent households. Perhaps 9m Americans lost their homes in the recession; unemployment rose by over 8m. While households paid down debt, consumer spending was ravaged.

It has taken fully ten years for the countervailing economic stimulus to restore America’s economy to health. Many of Europe’s economies still suffer from weak aggregate demand. Fiscal and monetary policy could have done more, sooner, to bring about recovery. They were held back by mostly misplaced concerns about government debt and inflation. The fact that this failing is not more widely acknowledged augurs badly for the policy response next time.

Stagnation has, inevitably, fed populism. And, by looking for scapegoats and simplistic solutions that punish them, populism has made it harder to confront the real long-term problems that the crisis exposed. Three stand out: housing, offshore dollar finance and the euro.

To share divine

The precise shape of the next financial crisis is unclear—otherwise it would surely be avoided. But, in one way or another, it is likely to involve property. Rich-world governments have never properly reconciled a desire to boost home ownership with the need to avoid dangerous booms in household credit, as in the mid-2000s. In America the reluctance to confront this means that the taxpayer underwrites 70% of all new mortgage lending. Everywhere, regulations encourage banks to lend against property rather than make loans to businesses. The risk will be mitigated only when politicians embrace fundamental reforms, such as reducing household borrowing, with risk-sharing mortgages or permanent constraints on loan-to-value ratios. In America taxpayers should get out of the rotten business of guaranteeing mortgage debt. Sadly, populists are hardly likely to take on homeowners.

Next, the greenback. The crisis spread across borders because European banks ran out of the dollars they needed to pay back their dollar-denominated borrowing. The Fed acted as lender of last resort to the world, offering foreigners $1trn of liquidity. Since then, offshore dollar debts have roughly doubled. In the next crisis, America’s political system is unlikely to let the Fed act as the backstop to this vast system, even after Donald Trump leaves the White House. Finding ways to make offshore dollar finance safe, such as pooling dollar reserves among emerging-market countries, relies on international co-operation of the type that is fast falling out of fashion.

The rise of nationalism also hinders Europe from solving the euro’s structural problems. The crisis showed how a country’s banks and its government are intertwined: the state struggles to borrow enough to support the banks, which are dragged down by the falling value of government debt. This “doom loop” remains mostly intact. Until Europe shares more risks across national borders—whether through financial markets, deposit guarantees or fiscal policy—the future of the single currency will remain in doubt. A chaotic collapse of the euro would make the crisis of 2008 look like a picnic.

Policymakers have made the economy safer, but they still have plenty of lessons to learn. And fracturing geopolitics make globalised finance even harder to deal with. A decade after Lehman failed, finance has a worrying amount to fix.


Interview with Wolfgang Ischinger

'We Are Experiencing an Epochal Shift'

Interview Conducted by Britta Sandberg and Mathieu von Rohr

In a DER SPIEGEL interview, former German Ambassador to Washington Wolfgang Ischinger says that U.S. President Donald Trump is endangering the world order. For Germany, the epochal shift amounts to no less than a loss of identity.

Wolfgang Ischinger, chairman of the Munich Security Conference


DER SPIEGEL: Mr. Ischinger, was there a single moment when you realized that the old world order was slipping?

Ischinger: Absolutely. It was in February 2007, the year before I took over the chairmanship of the Munich Security Conference. Vladimir Putin was speaking in Munich and in an extremely aggressive tone, he called into question the U.S. claim to leadership. I was sitting in the audience and, behind me, a journalist said: This is going to change the world. It was a turning point, the beginning of something new.

DER SPIEGEL: Was that clear to you at the time?

Ischinger: We didn't take it seriously enough. I'm not excluding myself. We tried to ignore the war in Georgia in 2008 and essentially tried to deny reality until March 2014, until the annexation of Crimea. Then, it wasn't possible any longer.

DER SPIEGEL: "The World in Danger" ("Welt in Gefahr") is the title of your new book. How bad is the situation?

Ischinger: We are experiencing an epochal shift. Since the collapse of the Soviet Union, the situation has never been as dangerous as it is today. Primarily because mutual trust has vanished. We can only see the rough outlines of what the new political age will look like. There is Russia's new role, China's expansion, violent conflicts around the world such as the war in Syria, the consequences of which we in Europe have particularly felt. A once reliable partner like Turkey is faltering, and we have experienced significant instability even within the European Union. But no politician has unsettled the world to the degree Donald Trump has. Since he entered office in January 2017, the entire liberal world order seems to be in danger.

DER SPIEGEL: Why are these disruptions to global politics taking place now?

Ischinger: There are many reasons. America's unipolar hegemony after 1990 is approaching its end and China is rising at the same time. That begs the question: Who will guarantee the erstwhile global order once the U.S. is no longer prepared to do so? Relations between Russia and the West are extremely strained. In this new world, prognostications regarding what will happen next have become much more difficult to make. Uncertainty and uneasiness characterize the global political situation.

DER SPIEGEL: Is Trump destroying the West with his rhetoric?

Ischinger: If it were only actions that mattered in foreign policy, I would be more sanguine. Because the U.S. is still doing more for NATO than all the rest of us put together. Unfortunately, the current situation isn't the only thing that matters. Words do too. And Trump's words act like poison to the cohesion of the West. The West needs a symbol, and that is what we have lost under Trump. And because we Germans finally became embedded in the West after a long journey over the last 70 years, it is a particularly painful loss, almost a loss of identity - much worse than for the French or the British.

DER SPIEGEL: Can't we just wait until Trump is gone?

Ischinger: The scar that will result will be difficult to heal. Things will never be quite the same as they used to be.

DER SPIEGEL: Why not?

Ischinger: Because Trump isn't to blame for everything. Even Barack Obama was no longer willing to take care of everything. For decades, Germany was able to outsource its security. This relatively harmonious relationship between the superpower and its voluntarily subordinate European partners is coming to an end and will not return in its erstwhile form. And it's not a bad thing that a process of emancipation has begun. Trump is forcing us to grow up.

DER SPIEGEL: In your discussions with heads of state and government, can you sense concern over what is currently taking place?

Ischinger: Yes, the unease and uncertainty have increased. It was bad enough that the Crimea annexation forced us to realize that our belief that all territorial questions in Europe had been definitively resolved was no longer true. Other security policy certainties have likewise proven illusory. And it begins with things that I grew up with, like NATO's Article 5, which guarantees that an attack on any alliance member will be treated as an attack on the entire alliance.

DER SPIEGEL: Is Germany sufficiently prepared for this new situation?

Ischinger: No. The popular sentence, "Germany is now surrounded by friends," has had disastrous consequences, as has now become clear. Yeah, all of our neighbors, with the exception of Switzerland, are now in the EU or in NATO. We saw that as a free ticket to Paradise and overlooked the fact that the periphery of and neighbors to the European Union -- in Eastern Europe, the Balkans and North Africa -- in no way had the same feeling of lasting peace that we did.

DER SPIEGEL: But have the Germans understood that they must change their role in this new world?

Ischinger: A lot of what the German government is doing is correct, but it isn't enough. Ever since Konrad Adenauer (Germany's first postwar chancellor), there have been two cornerstones of German politics: The European project and the trans-Atlantic bond, the EU and NATO. It is imperative that we invest more in these two cornerstones. The EU will cost more if we expect it to protect its external borders. And if we want to preserve NATO, then it is misguided for us to act with gentlemanly nonchalance as though we never agreed to the 2-percent goal (of increasing defense spending to 2 percent annually). We have an example to set. We are the largest, most substantial and most prosperous country in Europe. The strategic challenges we currently face are so significant that it is misguided to treat the balanced budget as some sort of holy grail to which all else is secondary.

DER SPIEGEL: Many politicians have demanded that Germany take on more responsibility in the world and spend more money on defense. But the Germans themselves are deeply skeptical of such a course.

Ischinger: I don't share your view. There was a public opinion survey taken recently by (the pollster) Allensbach. It found that more Germans are prepared to accept greater defense spending than we had actually thought. The mood among voters is not such that the government would be punished were it to do more to protect Germany and fulfill its alliance obligations. But it is necessary to explain convincingly why such a step is in our interest and that we are not just doing it because Trump told us to.

DER SPIEGEL: It doesn't look as though anyone has much of an interest in doing so.

Ischinger: If you want to win elections in Germany, it isn't a good recipe to tell the Germans that we are facing permanent change. But you also can't constantly serve up sleeping pills to the German electorate. We have no choice but to reform when it comes to security policy. We have to make some decisions, we have to set European foreign policy goals. In the last several years, I have seen little courage to do so.

DER SPIEGEL: Do you really believe it is possible to convince the Germans to become a military power again?

Ischinger: It's not about Germany becoming a power, it's about whether and how to push through European interests. We have to learn the lessons of the Syrian conflict. The acceptance of the refugees has cost us many billions of euros and has permanently changed the political landscape -- and unfortunately not for the better. What did we actually do to contain this conflict when such a thing was still possible? What did we do when large numbers of refugees first began arriving in Italy? Not much! The German government looked away at the time and more than anything, did all it could to avoid getting involved. Such an accusation is unavoidable, and now we are paying for it in the form of our helplessness in the face of the current drama.

DER SPIEGEL: What should we have done?

Ischinger: The EU didn't even have the courage to start a peace initiative. Just like during the Cold War, we left it to America and Russia. Why don't 500 million Europeans have the courage to say: Let's invite the conflict parties to the table? Because we couldn't agree and because we as the EU have nothing to offer militarily.

DER SPIEGEL: Do you have to be militarily strong to organize peace conferences?

Ischinger: Crisis diplomacy is easier to exercise when it is militarily backed. In no way am I a supporter of military interventions. But there's one thing I've learned in 40 years: Diplomacy absent the ability to assert military pressure is nothing but political symbolism. A small European state might be able to afford such a thing, but not Germany.

DER SPIEGEL: Do you believe Germany is dodging its responsibility?

Ischinger: When the strongest country, namely Germany, limits itself in the fight against Islamic State to shooting a few photos over Syria with a reconnaissance plane while leaving it to Denmark, with a population of just 5 million, to send a few real warplanes, then something isn't right. Germany often only does the bare minimum. That is not a recipe for leadership.

DER SPIEGEL: France and Great Britain are more practiced in taking on a global role. Is Germany even able to practice global politics?

Ischinger: It's not about transforming Germany into a global political actor, but about developing the EU to the point where it can resolutely and credibly defend the interests of its more than 500 million citizens.

DER SPIEGEL: In your book, you demand that Germany's Federal Security Council, which includes the chancellor and a number of government ministers, be made more robust and propose a panel dedicated to the coordination of European foreign and security policy.

Ischinger: At a time when a chilly wind is blowing, we need a systematic procedure for making decisions on security issues. And I have another proposal: We could, as proposed by (retired conservative politician) Volker Rühe, treat German military units that are active in certain EU or NATO missions in such a way that the German parliament doesn't have to grant its approval prior to each and every mission. The parliament would retain its veto and could put a stop to missions at any time. It wouldn't be the end of parliamentary control of the military, but it would be a signal to our partners that we want to be a more reliable partner.

DER SPIEGEL: Former German Foreign Minister Joschka Fischer recently told us: "If you ask me whether we are able to defend ourselves, my answer is: No!"

Ischinger: I agree. But it was never the intention for us to be able to defend ourselves. The idea has always been that we can defend ourselves collectively, as part of NATO or the EU. But we also have to invest in these systems. It's not about the 2 percent. The question is, what does Germany owe itself and its allies to be able to protect ourselves and to live up to our obligations?

DER SPIEGEL: So, NATO's 2-percent target isn't all that important after all?

Ischinger: The decisive point is how we transform European defense from the scattered regionalism of the 19th century into the integrated Europe of the 21st century. Does every small state really need its own mini-air force? We need a European defense union in which not every country is doing things on its own. Part of that is spending more, but not because it's written somewhere that we have to, but because we should do so out of our own interests. And we have to use the funds more intelligently -- for things like joint training, joint procurement and joint projects. EU states are very much capable of foreign policy and military credibility when they act together.

DER SPIEGEL: What steps should the EU take to increase its foreign policy credibility?

Ischinger: If we don't abandon the principle of consensus on European foreign policy decisions and finally move to majority decision-making in this area as well, the EU will never become a respected foreign policy actor. The best example for how we might be able to do that is what European Commission President Jean-Claude Juncker recently achieved in Washington. Because of the European treaties, he has the say when it comes to European trade policy. He was able to tell Trump: I represent 500 million Europeans, we are a trade power, even larger than the U.S., so let's now make a deal.

DER SPIEGEL: Do you expect German Chancellor Angela Merkel to leave a legacy on this issue?

Ischinger: In Emmanuel Macron, she has a French partner who has called for joint progress on EU reform. If we don't take the initiative now to create a Europe that can protect itself from internal and external threats, then we will have missed a huge opportunity. One that won't come back right away. Macron is not a panacea, but I view him as a great opportunity because he has given us the chance to think boldly together.

DER SPIEGEL: We have become so focused on Trump and Russia. Are we not ignoring an even more important issue in China?

Ischinger: China, of course, represents a significant future challenge. But we should avoid demonizing China. The question for us must be: What contribution must we make to ensure that China's rise does not result in military conflict? That is the global political challenge. The ancient Greek historian Thucydides once said that war is unavoidable when an established power is challenged by a new power. In his era, it was Sparta and Athens. The challenge for us is to avoid stumbling into that trap.

DER SPIEGEL: Are we currently seeing the end of traditional diplomacy? Trump has met with Putin and North Korean dictator Kim Jong Un with no preparation and heads of state are tussling on Twitter.

Ischinger: These Trumpian hip-shots are like fireworks. None of it is enduring. The North Koreans are apparently not thinking of abandoning their nuclear activities. Classic diplomacy has absolutely not outlived its usefulness. It is not a good idea to allow someone like Trump to negotiate on his own. Clever diplomacy requires a different tack. Such a strategy involves sending a diplomat in advance to negotiate something, so that the head of government can then say: Yeah, I like that, we can sign that -- or, that needs to be improved. The issues have become so complex that not only classic diplomats are necessary, but also experts.

DER SPIEGEL: Isn't it better when Trump and Putin speak directly to each other, even if nothing has been prepared?

Ischinger: Of course, it is important, correct and in our interest when they speak to each other. It would be even better if Trump's discussions were so carefully prepared that concrete results would come out of them. Unfortunately, that has not been the case thus far.

DER SPIEGEL: What do you think the German government should do in the face of Trump's frontal attacks on Germany?

Ischinger: I would double the number of German diplomats in Washington and in the German consulates in the U.S. Funding for public relations in the U.S. should be massively increased, together with the numerous German companies there. Far too rarely do Trump voters in Kansas or Idaho hear positive stories about the friendly and hard-working Germans who have created so many jobs in America.

DER SPIEGEL: Mr. Ischinger, we thank you for this interview.


Ukraine: On the front line of Europe’s forgotten war

After four years, and 10,000 deaths, the conflict with Russia in the east of the country has slipped off the west’s political agenda

David Bond and Roman Olearchyk in Avdiivka, Ukraine 


Staring straight ahead, Anton Akastyolov describes what it feels like to be fighting on the frontline of Russia’s proxy war with the west. “Every day you think about death,” the 23-year-old Ukrainian private says, standing in a shattered residential block on the edge of the eastern city of Avdiivka.

This is Europe’s forgotten war, a conflict that has claimed more than 10,000 lives, almost one-third of them civilians, during the past four years, making it the bloodiest in Europe since the Balkans in the 1990s and one of the longest-running in almost a century.

Western powers blame Russian president Vladimir Putin for starting the conflict by illegally annexing Crimea in 2014 — the first appropriation of European territory since the second world war — providing the catalyst for Russian-backed separatists to seize the eastern Ukrainian cities of Donetsk and Lugansk.


Anton Akastyolov in Avdiivka © Charlie Bibby/FT


While Mr Putin says Crimea has always been part of Russia, his actions in Ukraine are seen as part of a growing charge sheet that includes US election meddling, military intervention to back the regime of Bashar al-Assad in Syria, and the nerve agent attack on a former Russian double agent in the British cathedral city of Salisbury.

“In their hope to recreate what they view is a great Russia again, they are pushing forward west into Europe,” says Lieutenant General Serhiy Nayev, the commander of Ukraine’s joint forces. “Russia has no interest in bringing down the temperature, not with the western world, not with Ukraine.”

Ukraine map


So while the war has reached stalemate, it still smoulders.

Bound by the terms of the 2015 Minsk ceasefire agreements, both sides are barred from using air strikes, tanks and heavy weaponry. This has created the conditions for an attritional land war which marks a throwback to another age, where soldiers fight in trenches with shells, grenades and sniper fire. Consequently, the death toll continues to rise. The Organisation for Security and Co-operation in Europe, which monitors the conflict, in August said that a total of 160 people had been killed on both sides so far this year.


Lyubov Kolesova holds a portrait of her missing son Igor Grizenko at their home in Avdiivka


There are no signs of a resolution in sight. The war was barely on the agenda at the Helsinki summit between US president Donald Trump and Mr Putin in July. And despite attempts by the US and its allies to modernise and arm Ukraine’s 200,000-strong military forces, people in Avdiivka feel abandoned by the west.

“They don’t care,” says Lyubov Kolesova, a resident whose 28-year-old son went missing in the early days of the war. “If you don’t live here, you won’t understand.”



Sunflower fields along Ukraine's highway 20


Ukraine’s highway 20 cuts through seemingly endless fields of sunflowers, making it feel more like the south of France than Europe’s borderlands with Russia. Before the war, this road was one of the symbols of Ukrainian economic progress, built primarily for the 2012 European football championships.

Now it forms part of the front line. As the highway nears Avdiivka, about 20km from the separatist stronghold of Donetsk, it becomes too treacherous to continue. Access to the city can only be made via bumpy back roads.

Yet daytime in Avdiivka can be deceptively calm. Parents stroll the streets with young children while a group of pensioners has set up an impromptu market in the centre, selling milk and other produce.

But the war is never far away.

In the distance, occasional gunfire can be heard along with the deep boom of shelling. At the entrance to their Soviet-built flats on Semashko Street, Galya, 51, asks: “How much longer must we endure this? It’s been five years already. Will this continue another 20 years?”


Pavel, a 45-year-old Ukrainian soldier, says the nature of the war has changed


Much of the fighting in Avdiivka takes place in an industrial area on the outskirts of the city, where troops on both sides are well dug in. Pavel, a bearded and battle-hardened 45-year-old Ukrainian soldier, says the nature of the war has changed.

“Instead of the heavy weaponry we have snipers, which can be even more dangerous because you relax a bit,” he says. “Then a bullet hits your head.”

Clutching his Kalashnikov rifle, which looks like a relic from the 1970s, his comrade Artur adds: “The faster you move, the longer you live.”

The shortest distance between our positions is 70m to 80m,” he adds. “You can see their eyes.”

Sometimes, he says, they are so close to the enemy he can hear the distinct accents of opponents from “Russia, South Ossetia and Chechnya”.

His account backs claims — denied by Moscow — that Ukraine’s army is facing a hybrid force of Russian soldiers and local separatist militants under command from the Kremlin. “They created the military forces . . . [do] not make any mistake about it, the forces in the east are 100 per cent commanded by Russia,” says Kurt Volker, the US special envoy to Ukraine.

Ukraine separatists map

Eduard Basurin, deputy commander of the 20,000-strong Donetsk-based separatist forces, denies the claim. “Imagine if the Russian army were here. I think that the war would unfold differently,” he says. “Those that talk about this don’t provide facts to uphold them.”

Getting a clear picture of life on the other side of the war is difficult. Officials from the Russian-backed Donetsk People’s Republic — which is not internationally recognised — declined access to the Financial Times to report from the territory, but people from the DPR regularly cross the front line.

At a civilian crossing point at Maiorska near the separatist-held city of Horlivka, a dozen cars are queueing to cross into the DPR. The International Committee of the Red Cross said 1m crossings take place at points like this every month, which close periodically when fighting flares up.

Waiting in her car, Horlivka resident Svetlana explained that she often makes the journey to the Ukrainian-controlled side with her father, Nikolay, to collect his pension and buy produce, some of which is cheaper there.

“Everyone there on that side also wants this war to end,” Svetlana says, gesturing towards the Russian-backed territories. Her father adds: “We lived in peace and understanding before. Everything was fine.”

Underscoring dangers in the region that extend far from the front lines, Alexander Zakharchenko, self-declared leader of the DPR-based separatist militants, was last week killed by an improvised explosive at a Donetsk café. Russia rushed to blame Ukraine for orchestrating the “terrorist act”, while officials in the capital Kiev denied involvement, insisting turf wars and infighting within what they describe as the “Russian-occupied” region was to blame.


Ukrainian soldiers visit a kindergarten near the town of Ivanivske as part of a 'hearts and minds' campaign © Charlie Bibby/FT


Alexander Hug, deputy chief monitor of the OSCE mission to Ukraine, who visited Donetsk in early August, says: “If you go to districts in Donetsk, close to the contact line or the destroyed airport, life is very difficult. Living standards are bad, infrastructure is heavily damaged. Gas, electricity and water are hard to come by.”

For his part, Mr Basurin, the separatist commander, blames a Ukrainian blockade for these economic woes. “We are trying to revive the economy,” he says.

In Ukrainian-controlled areas, the authorities are not only trying to repel a Russian-backed enemy, they are also having to win the hearts and minds of Russian speakers. With this in mind, the army and other state institutions have blocked Russian television, and they visit kindergartens and schools to promote “patriotic teachings”.

“Battling with Russia is difficult as objectively it’s a bigger country with more military might,” says Major General Oleksandr Golodnyuk, visiting a kindergarten in the village of Ivanivske. “But winning the minds of our people is a battle within our grasp that must be won.”


Lieutenant General Serhiy Nayev arrives at a training exercise in Pokrovsk, eastern Ukraine


In the opening phases of the war, Ukrainian forces were hampered by a lack of combat training and rusting Soviet equipment. They were also paralysed by another throwback to the cold war era: a top down command structure which caused the army’s middle ranks to freeze when their opponents used electronic warfare to jam communications.

Since then, the US and other western powers have been working to modernise Ukraine’s forces — including more than $1bn in financial support and the Trump administration’s move in March to provide 210 tank-busting Javelin missiles.

The weapons are seen by military analysts as a game-changer in the event of an all-out assault by Russian-backed forces. Lt Gen Nayev says western backing is necessary if Ukraine is to resist the Russian threat on Europe’s doorstep, but added that his own troops have already been transformed.


Ukrainian soldiers are put through their paces in training exercises © Charlie Bibby/FT


The general, an imposing figure who commanded troops in the bloody battle for Donetsk airport in 2014, has come to a military training ground near the eastern city of Pokrovsk to watch soldiers test Ukraine’s homemade answer to the Javelin — the Stugna.

He says Ukraine’s forces are now “not only capable but ready” to repel Russian-backed separatists, which he claims have [over] 400 tanks — more than the UK. Before testing the Stugnas, troops launched a series of Soviet-era weapons including Shturm and Fagot missiles, demonstrating clearly the handicaps they faced in the initial stages of the conflict.

Some rockets failed to launch. One fell off the side of an armoured vehicle while another misfired, smashing into the ground and leaving a training trench in flames. If this was a deliberate display of ineptitude, it felt a dangerous one. The Stugnas, meanwhile, hit the target four times out of four, prompting a howl of delight from Lt Gen Nayev. “Yes! You see . . . Ukraine made,” he shouted.

Newer equipment is filtering through, but some on the front line still complain of having to fight with Kalashnikovs older than themselves. One soldier revealed he and his fellow fighters had made a Javelin copy out of wood to fool the enemy.

For Ukraine’s western partners, the hope is that such improvisation will soon be a thing of the past, with its armed forces set to meet Nato standards on everything from governance to training and equipment.

To help Kiev achieve this, a group of more than 200 US trainers is based at Yavoriv, a vast military complex near Ukraine’s border with Poland. Here senior US soldiers, such as Staff Sergeant Jamah Figaro, instruct Ukrainian officers on how to train their troops. “They are very motivated,” Sgt Figaro says. “It’s their country. They are trying to get their land back.”

Sgt Figaro says the US is also learning from their Ukrainian counterparts.

“The US army was [used to] operating in contingencies like Iraq and Afghanistan,” he says, referring to offensive wars in which the US dominated the airspace. “[It’s] nothing similar to what the Ukrainians are facing, this [trench warfare] is like a more near-peer fight they are fighting.

“We haven’t seen something like that since world war two,” he adds.


A couple say goodbye on the train platform in Kiev as the train departs for eastern Ukraine © Charlie Bibby/FT

 
In Kiev, more than 700km from the eastern war zone, Stanislav Fedorchuk raises his hand and places it tenderly on a picture of his friend Yuriy Matushcak. Nicknamed “the wind”, Matushcak died at the battle of Ilovaisk, a big defeat for Ukrainian forces, in August 2014.

His face is now one of hundreds on the outer wall of St Michael’s monastery in the capital, a reminder to those passing by on a balmy Sunday evening that this is a country at war.

“We were waiting one year to know if he had died or not. We had no body,” says Mr Fedorchuk, adding that his remains were later found and buried with other fallen soldiers. Mr Fedorchuk fled Donetsk in 2014 and is one of an estimated 1.5m people displaced by the conflict.


Stanislav Fedorchuk at a memorial wall outside St Michael's monastery in Kiev dedicated to those who have died in the conflict © Charlie Bibby/FT


As the war rumbles into its fifth year, the prospect of a military or diplomatic solution looks remote. The US and other western powers want Russian forces to leave Ukraine, but Mr Putin shows no sign of changing his approach. The US national security adviser John Bolton recently declared that when it comes to Ukraine, Washington and Moscow are going to “have to agree to disagree”.

The US has stepped up sanctions and the UK is pushing for more diplomatic action. Still, Lt Gen Nayev urges the west to wake up to the threat from Russia and even draws comparisons with 1930s appeasement. “We saw how this shameful appeasement brought upon world war two,” he says.

Back in Avdiivka, private Akastyolov struggles to find the words to sum up the future he and his country face. “Tell them we will win,” an army press officer prompts.

The young private rolls his eyes, saying, after a few seconds: “I don’t know if we will win.”