China, Brexit, and the U.S. Election — What Eurasia Group’s Ian Bremmer Expects

By Leslie P. Norton

                                      Ian Bremmer Photograph by Erik Tanner          

  When something big happens in the world—pretty much a daily event at this point—Ian Bremmer is there to explain it. The political scientist, founder of the Eurasia Group consultancy, and PBS host has lately been telling everybody about what he calls the GZero World, in which post–World War II institutions are rapidly losing influence. We caught up with Bremmer, 49, to talk about the geopolitical unwinding that has massive implications for investors. An edited version of our conversation follows.

Barron’s: You’ve written a lot about the geopolitical recession, which isn’t an economic term.

Bremmer: Geopolitics, like economics, are cyclical. People don’t recognize that because geopolitical cycles are a lot longer. We had a good run of U.S.-led global institutions [like the G-7, the seven largest advance economies], reflecting a new order after World War II. Now they’re unwinding. We’re entering an interregnum where the institutions increasingly don’t work. We need to build new ones.

Why is this happening?

It’s extraordinary when you have Western-led global institutions, but economic, political, and even military power increasingly residing outside the trans-Atlantic. The U.S. can talk about a pivot to Asia, but it’s really hard for the global architecture to do this. It’s hard to get troops out of the Middle East. It’s hard to compromise with the Chinese, who have very different institutions and values and norms.

The U.S. foreign-policy establishment once believed that as China became wealthier, it would align more with the U.S., or fail. That was just wrong. In the past three years, the biggest change was created not by President Donald Trump in the U.S. but by President Xi Jinping in China, with his anticorruption program, consolidation of power, end to term limits, the Belt and Road infrastructure initiative, and the AI 2030 and Made in China 2025 policies. This is world-changing stuff.

Are there other reasons?

A growing inability of Western governments to perform for their populations.

There’s extraordinary division with the rise of populism. Other countries, like Russia, are looking to exploit it and make it worse, and China is trying to move into the space created when the West isn’t doing much.
Finally, technology increasingly doesn’t serve the purposes of liberal democracies. It has moved from undermining authoritarian states to supporting them, as the data revolution [enables] surveillance data and social media. These things make the U.S. weaker and more divided, and make China and other authoritarian states stronger. That’s exactly the opposite from what technological advances achieved 10 years ago.
The United Nations secretary general recently observed that the world is splitting into two camps—the U.S. and China.

It’s more West and China-plus. When you have two groups of investors with such dramatically different views of the world, it creates a lot more volatility and risk. Right after the 2008 crisis, a number of Chinese said, “Maybe [the U.S.] economic model doesn’t really work; maybe we can move away from the dollar.” Very quickly they were disabused. It’s different now: Asians think the U.S. is in very serious, inevitable decline; that Trump is driving America off a cliff; and that the Asians are the ones doing long-term strategy. They’re also much more resistant to the kind of populism seen in so many of the democracies in the West.

Do you agree?

Not completely. I do think that U.S. influence and power is in very serious—and structural—decline. And Trump is not helping, to put it mildly. However, the U.S. is not in decline as a country. Look at the biggest objective transformations of the past 10 or 20 years—the energy revolution, the rise of extraordinary technologically and data-empowered companies that are functional monopolies. These are U.S., not Western trends. Americans aren’t experiencing the geopolitical recession the way our allies do, so we’re not incentivized to do much about it.
What countries are most affected by the geopolitical recession?

Turkey is massively affected, as America and NATO’s consistent, strong global-policeman role [is diminished]. Another group is the countries under the American security umbrella in Asia, which don’t know how to balance China’s economic rise: Japan, Singapore, South Korea, Vietnam. Then you have countries in Africa, which have been accommodated by the Chinese model and Chinese money.

Europeans are much, much more affected than the Americans—they’re a transmission belt for all the instability from Africa and the Middle East. Russia is able to do much more in terms of traditional espionage, political influence, and asymmetrical warfare on the ground in Europe, because its in its backyard.

One more point. The two countries that could best respond to a geopolitical recession are the ones that have benefited most by it: China because it represents an opportunity, and America because we’re insulated. We’re buggered. I’m sorry, you were saying?
How does this lead to a market view?

One, this is still pretty bullish for U.S. markets. Two, companies that don’t understand these changes are going to get hurt. Apple [ticker: AAPL] doesn’t get this. Its model is building the best possible consumer electronics with some privacy and data security. That’s just not going to work in China. [AMZN] has a much smarter model. It wants to work with the U.S. government. Its second headquarters, just outside Washington, D.C., will get a lot of big contracts, and it will be part of the infrastructure of the U.S. based Internet of Things.

Who wins the U.S. presidential election?

I don’t know. The impeachment issue is serious. There’s a low but real possibility that, if you keep having significant Republicans functionally turning state’s evidence against the president, you could start to lose some senators. The timing of the Syria [troop pullback] wasn’t great for Trump. If the Republicans do vote in favor of impeachment in the Senate, they’re basically giving up on the presidency in 2020. The bar is high. I don’t think it’s a 1% chance. I think it’s 10% to 15%.
Who will be the Democratic nominee?

Not Biden. Now that Warren is the front-runner, there’ll be a lot of money against her. I don’t think all of Biden’s support will go to Warren. A lot will be up for grabs, with more centrist candidates. No question in my mind that any of the Democrats will beat Trump by millions of the popular votes. That doesn’t mean they’re going to win the election. You’ve got to win these swing states, and Trump has a lot of money and a policy orientation that, for many of them, is very attractive. He’s also a relentless campaigner, and he likes campaigning. But he’s facing the worst set of objective facts around his administration.

What happens in the Middle East, as the U.S. steps away from Syria and tries to counter Iranian aggression?

This has been overstated by a foreign-policy establishment that hates everything about Trump. The Syrian war was lost under Obama. For legitimate reasons, the U.S. didn’t have a strong interest in Syria. We weren’t willing to fight another war there, and that’s why Assad won. Now, the Kurds have sided with Russia and Assad. It may be easier to move toward a U.N.-brokered peace settlement, in Assad’s favor. The Syrian people are getting screwed in all this, but that’s not new. The real concern is that you’ll see more attacks in the region from the Islamic State, maybe some in Europe, and maybe against U.S. assets in the region.

Regarding Iran, Trump was absolutely unwilling to support the Saudis with strikes, despite the [Iranian] attack that took 50% of their oil off the market. He sent some troops over that the Saudis are paying for, and he started a cyberattack. He doesn’t want a war. What he really wants is direct negotiations with Iran, like with North Korea. He really wants a deal. It doesn’t need to be much more than the one Obama already had with Iran that he pulled out of. [It] will be hard for Trump, because he doesn’t have a team to get the hard diplomacy done that Obama did.

Let’s talk about China and trade.

I don’t think there’s even a limited deal. The Chinese haven’t signed anything yet. They basically offered the same thing they offered when U.S. Trade Representative [Robert] Lighthizer walked away a few months ago. The only thing that has changed is that Trump is a little more concerned about the economy and his election—a little more desperate for a deal. The Chinese don’t trust Trump. Xi feels like he has given up a fair amount of political capital already, and hasn’t got anything done. So they’re willing to wait him out, particularly because they see that Trump’s appetite for further escalation with the softening U.S. economy is low. U.S.-China relations are objectively more confrontational today than they were three, six, 12 months ago. That trend will continue.

Your annual Top 10 Risks list won’t be out for a while. What is the biggest short-term risk for global investors?
The role of the U.S. on the global stage. Historically, when you think about global political risk, you think about rogues, you think about emerging markets, you think about country risk. You don’t think of the U.S. driving global political risk. That’s changing.

Thanks, Ian.


by Egon von Greyerz

Something is rotten in the state of Denmark the world (from Shakespeare’s Hamlet).

In a world that cannot survive without incessant deficit spending, money printing and negative interest rates, there is clearly something very rotten. It is not only rotten but it stinks!

Yes it stinks of lies, deceit and moral decadence.

So why doesn’t anyone stand up to tell the world where we are heading.

Well, for the simple reason that no politician can tell the truth.

Because if they did, they wouldn’t be elected.

The principal purpose of any politician is to buy votes and to get votes you can never speak the truth.

Also, there are so many vested interests with unlimited rewards. The moneymen who control the financial system have all to gain from creating false markets, false money and false interest rates.


The Roman philosopher and statesman Seneca said: “Veritas Nunquam Perit” (The Truth Never Perishes).

That might very well be true but it can be suppressed for a very long time as we are seeing now all around the world.

Let us first consider the biggest lie which is money.

For 5,000 years, the only real money has been gold (and at times silver).

Whenever the financial system has deviated from that simple principle, by creating false money, it has ended in disaster for the world, whether that has been done with silver coins filled with zinc or copper or by just printing paper money.


And that is where we are heading now. A catastrophic course of events was triggered when Nixon closed the gold window on August 15th, 1971.

Since then global debt has exploded and all currencies have imploded.

Debt, derivatives and unfunded liabilities have gone from manageable amounts in 1971 to over $2 quadrillion today.

And every single currency has lost 97-99% in real terms.

As I mentioned last week, the world, the politicians and the UN are all focusing on the wrong problem.

The destruction of the world economy will have consequences of a magnitude that is exponentially greater than climate cycles.

We are now at the point when we will not be able to change the course of either of the two.

Climate is determined by very long cycles that humans have virtually zero influence on.

With regards the financial system, there was a time when it could have been saved.

But that time is long gone.

Now we just have to let it take its course which will be totally catastrophic for the world.

So why is no one seeing what is happening and why is no one standing up to say that the Emperor is totally naked?

The truth is very uncomfortable and painful but it does never perish.

It is an incontrovertible fact that virtually all the fiat money that is created by governments, central banks and commercial banks is totally worthless and therefore false.

If a government prints money out of thin air to cover deficit spending, that money has ZERO value since all the work required to create it was to press a button on a computer.

We also know that the money has zero value because no bank or central bank is prepared to pay interest on deposits.

Instead because money is worthless these bankers want to be paid to hold the money.

It is really quite logical.

Why should you pay interest on money which has zero value.


And when a bank receives a $1,000 deposit and then lends out that same money ten times or more, that money is also worthless since it has cost $0 to issue the loans.

It is the same with a credit card company, or car financing, they all issue fake money created by the touch of a button.

It is this vicious cycle of money printing that has inflated asset bubbles to an extreme today.

We all know what happens when a bubble gets too big. IT POPS!

And when it pops, all the air that was inside the bubble just disappears.

For the ones who don’t understand what this means practically, let me explain. Let us start with the asset bubbles.

When the global stock, property and other bubble asset markets pop, all these assets will lose at least 95% of their value in real terms.

The best way to measure real terms is obviously gold since that is the only money which has survived and maintained its purchasing power for thousands of years.

And if we look at the debt bubble, global debt is at least $270 trillion.

But when the debt bubble pops so will other liabilities like the $1.5 quadrillion of derivatives.

So when the debt bubble pops, virtually all that fiat money becomes totally worthless.

No one can repay it and no one is willing to buy it.

I know that the above two paragraphs are a very simplified explanation of what will happen over coming years. But hopefully it makes it easy to understand.

These events will obviously not happen in one go. It will most probably start with stock markets first crashing which will put pressure on credit markets.

More QE will follow but that will only have a short term effect.

More crashes, more money printing, inflation, hyperinflation, credit defaults and bank defaults.

It will all unravel relatively quickly until their will be a deflationary implosion of most assets.

I outlined it briefly in my article last week called “Global Warning”.

We had the first clear signals from several major central banks that something was rotten in the world financial system already in August when the Fed, ECB and BOJ all declared that they would do what it takes to support the system.

I wrote about this important event in my article from August 29th.


Then in September the Fed started overnight Repos of $75 billion increasing to $100 billion.

They also undertook 14 day Repos of $ 30 billion increasing to $60 billion.

Following on from that the Fed has now announced that they will start QE of $60 billion per month.

But we mustn’t call it QE according to the Fed.

So let us just call it money printing because that is what it is.

The President of the Minneapolis Fed said:

“This is not about changing the stance of monetary policy.

This is about making sure markets are functioning.

This is kind of just a plumbing issue.”

He is of course right, it is a plumbing issue.

But the problem is that the financial system is leaking like a sieve with no chance of plugging all the holes.

Between the end of 2017 and 2019 the Fed reduced its balance sheet by $700 billion from $4.5 trillion to $3.8 trillion.

As always, the Fed hasn’t got a clue.

They didn’t understand that there was no chance to take away the punch bowl from a system that couldn’t survive without a constant feed of more printed money.

The problem is that the system won’t survive with more money printing either.

Because you can never solve a debt problem with more debt.

So either way they are doomed.

So the Fed is now joining the ECB which will now start to print € 20 billion a month indefinitely.

The BOJ has of course never stopped printing.

They own 50% of all Japanese bonds and are supporting the stock market aggressively.

The BOJ balance sheet has gone up 8X since 1999 and is now Yen 560 trillion ($5 trillion).

Yes, the system is rotten and is now starting to smell.

The actions by the Fed in particular in the last few weeks smell of panic.

Is there a problem with JP Morgan, or Bank of America, or maybe the Fed is supporting the bankrupt Deutsche Bank?

We will probably soon find out where the biggest pressures are.

On top of the bank problems, corporate debt is getting riskier by the day. The financing of companies like We Work and Merlin are clear signs of how dangerous this market has become.

The central banks are already fire fighting and so far very few people are aware of the fires.

But it is only a matter of time before these pressures in the financial system will spread like wildfires.


Investment markets will soon reflect the risks in the financial system.

Stock markets are likely to fall heavily this autumn and the precarious month of October isn’t over yet.

But potentially the fall might not happen until early next year.

But the risk is there today.

The dollar is extremely weak.

In spite of paying the highest interest of any major currency, the dollar is now weakening and is probably starting the final leg to ZERO.

Finally, the precious metals have merely just started to reflect the risks in the financial system.

The small correction that we have just seen is finishing.

But no use worrying about these small movements in the metals.

Physical gold and silver will soon start their journey to multiples of today’s prices.

But more importantly, they will be life savers as the financial system crumbles.

The Race Is On for The Future of Bond Trading

Shares of electronic bond-trading platform MarketAxess shares have soared, but many players are seeking a piece of the evolving market

By Telis Demos

Rick McVey, CEO of MarketAxess. The electronic bond-trading company recently reported a 30% jump in revenue. Photo: Amy Lombard for The Wall Street Journal

Wall Street has a new bond king. But as always, there are rivals for the crown.

Last week, MarketAxess MKTX -1.54%▲ reported a 30% jump in revenue and 40% jump in net income, both ahead of expectations. The company is in the business of electronic bond trading, offering venues and tools for banks, investment managers and others to trade corporates, munis and other instruments without picking up the phone.

Though stocks and currencies have long gone the way of trading automatically or by click-in centralized marketplaces, about 70% of investment-grade bonds in the U.S. and more than 80% of high-yield bonds still trade much more manually, through conversations or ad hoc messages between traders and dealers, according to Greenwich Associates.

The near-universal expectation is that this share will drop precipitously over the years to come as electronification of bond trading gains ground. That gives MarketAxess, by far the biggest of a handful of electronic bond platforms, a huge runway.

But owning that opportunity comes at a steep price: About 57 times next-12-month earnings for MarketAxess, on par with ultra-popular consumer-facing technology names like Square or Netflix.

At that nosebleed level, the main question is whether anything could start to impinge on the company’s growth story. After a huge run, the shares have already corrected a bit in September’s rotation out of momentum stocks, coming off a peak valuation of around 70 times.

One risk is that big banks’ desks figure out a way to keep more trade execution share for themselves, in part by setting up direct electronic links to clients. Dealers, for example, have recently embraced a new way to trade bonds called portfolio trading, which encourages clients to trade baskets of bonds rather than individual ones. This could, in theory, shift some trading away from electronic marketplaces. Already, about 2% to 4% of bond volume is now being traded in such portfolios, MarketAxess said Wednesday.

Things move quickly in this world, though. MarketAxess says it too is introducing a product designed to help clients price and execute portfolio trades. Portfolio trading could even spur more electronic trades, Marketaxess noted, as balance-sheet-constrained banks look to unload risk. Nonbank ETF market-makers are emerging as some big electronic customers, and might be drawn in to arbitrage opportunities created by this dynamic.

Perhaps the biggest unknown is the competitive landscape. There are many players in electronic fixed-income trading, from Bloomberg to BlackRock,that stand to have roles as the market matures. The growing electronic pie may enable all to keep growing for a long time.

But some big names will also be competing head-to-head. Recently listed Tradeweb Marketsis already handling some portfolio trading and has nabbed share of corporates trading by linking bonds to its big Treasurys rate trading business. MarketAxess recently acquired a smaller Treasurys platform it hopes to expand.

Stock-and-futures giant Intercontinental Exchange,known as ICE, has bought bond marketplaces, such as BondPoint, and bond data providers, such as IDC, in recent years. It is beginning to unveil its own strategy for how it will unite those assets and tackle the bond market holistically. ICE says its new ETF hub will help it compete directly for institutional bond trade execution.

ICE and Tradeweb are set to report earnings in the coming weeks. Investors in MarketAxess would be wise to pay close attention.

Bond trading is going electronic, but the ultimate spoils from that transition are still up for grabs.

Why Rich Cities Rebel

Having lost touch with public sentiment, officials in Paris, Hong Kong, and Santiago failed to anticipate that a seemingly modest policy action (a fuel-tax increase, an extradition bill, and higher metro prices, respectively) would trigger a massive social explosion.

Jeffrey D. Sachs

sachs315_Pablo Rojas MadariagaNurPhoto via Getty Images_chileprotestmanbulletface

NEW YORK – Three of the world’s more affluent cities have erupted in protests and unrest this year. Paris has faced waves of protests and rioting since November 2018, soon after French President Emmanuel Macron raised fuel taxes. Hong Kong has been in upheaval since March, after Chief Executive Carrie Lam proposed a law to allow extradition to the Chinese mainland.

And Santiago exploded in rioting this month after President Sebastian Piñera ordered an increase in metro prices. Each protest has its distinct local factors, but, taken together, they tell a larger story of what can happen when a sense of unfairness combines with a widespread perception of low social mobility.

By the traditional metric of GDP per capita, the three cities are paragons of economic success. Per capita income is around $40,000 in Hong Kong, more than $60,000 in Paris, and around $18,000 in Santiago, one of the wealthiest cities in Latin America. In the 2019 Global Competitiveness Report issued by the World Economic Forum, Hong Kong ranks third, France 15th, and Chile 33rd (the best in Latin America by a wide margin).

Yet, while these countries are quite rich and competitive by conventional standards, their populations are dissatisfied with key aspects of their lives. According to the 2019 World Happiness Report, the citizens of Hong Kong, France, and Chile feel that their lives are stuck in important ways.

Each year, the Gallup Poll asks people all over the world, “Are you satisfied or dissatisfied with your freedom to choose what you do with your life?” While Hong Kong ranks ninth globally in GDP per capita, it ranks far lower, in 66th place, in terms of the public’s perception of personal freedom to choose a life course. The same discrepancy is apparent in France (25th in GDP per capita but 69th in freedom to choose) and Chile (48th and 98th, respectively).

Ironically, both the Heritage Foundation and Simon Fraser University rank Hong Kong as having the most economic freedom in the entire world, yet Hong Kong residents despair of their freedom to choose what to do with their lives. In all three countries, urban young people not born into wealth despair of their chances of finding affordable housing and a decent job.
In Hong Kong, property prices relative to average salaries are among the highest in the world. Chile has the highest income inequality in the OECD, the club of high-income countries. In France, children of elite families have vast advantages in their life course.

Because of very high housing prices, most people are pushed away from the central business districts and typically depend on personal vehicles or public transport to get to work. Much of the public may thus be especially sensitive to changes in transportation prices, as shown by the explosion of protests in Paris and Santiago.

Hong Kong, France, and Chile are hardly alone in facing a crisis of social mobility and grievances over inequality. The United States is experiencing soaring suicide rates and other signs of social distress, such as mass shootings, at a time of unprecedented inequality and a collapse in public trust in government. The US will certainly see more social explosions ahead if we continue with politics and economics as usual.

If we are to head off that outcome, we must draw some lessons from the three recent cases. All three governments were blindsided by the protests. Having lost touch with public sentiment, they failed to anticipate that a seemingly modest policy action (Hong Kong’s extradition bill, France’s fuel-tax increase, and higher metro prices in Chile) would trigger a massive social explosion.

Perhaps most important, and least surprising, traditional economic measures of wellbeing are wholly insufficient to gauge the public’s real sentiments. GDP per capita measures an economy’s average income, but says nothing about its distribution, people’s perceptions of fairness or injustice, the public’s sense of financial vulnerability, or other conditions (such as trust in the government) that weigh heavily on the overall quality of life.

And rankings like the World Economic Forum’s Global Competitive Index, the Heritage Foundation’s Index of Economic Freedom, and Simon Fraser University’s measure of Economic Freedom of the World also capture far too little about the public’s subjective sense of fairness, freedom to make life choices, the government’s honesty, and the perceived trustworthiness of fellow citizens.

To learn about such sentiments, it is necessary to ask the public directly about their life satisfaction, sense of personal freedom, trust in government and compatriots, and about other dimensions of social life that bear heavily on life quality and therefore on the prospects of social upheaval. That’s the approach taken by Gallup’s annual surveys on wellbeing, which my colleagues and I report on each year in the World Happiness Report.

The idea of sustainable development, reflected in the 17 Sustainable Development Goals (SDGs) adopted by the world’s governments in 2015, is to move beyond traditional indicators such as GDP growth and per capita income, to a much richer set of objectives, including social fairness, trust, and environmental sustainability. The SDGs, for example, draw specific attention not only to income inequality (SDG 10), but also to broader measures of wellbeing (SDG 3).

It behooves every society to take the pulse of its population and heed well the sources of social unhappiness and distrust. Economic growth without fairness and environmental sustainability is a recipe for disorder, not for wellbeing. We will need far greater provision of public services, more redistribution of income from rich to poor, and more public investment to achieve environmental sustainability.

Even apparently sensible policies such as ending fuel subsidies or raising metro prices to cover costs will lead to massive upheavals if carried out under conditions of low social trust, high inequality, and a widely shared sense of unfairness.

Jeffrey D. Sachs, Professor of Sustainable Development andProfessor of Health Policy and Management at Columbia University,is Director of Columbia’s Center for Sustainable Development andof the UN Sustainable Development Solutions Network. His books include The End of Poverty, Common Wealth, The Age of Sustainable Development, Building the New American Economy, and most recently, A New Foreign Policy: Beyond American Exceptionalism.

Fumbling Around In The Dark

by: The Heisenberg

- On Friday, a friend of mine (one of the precious few I've got left) asked how I would teach an entry-level finance course in light of upside down markets.

- I was immediately reminded of an October 17 memo from Howard Marks.

- The fact is, valuing companies is no longer straightforward. Nobody quite knows how to do it anymore.

- One key question that emerges is: Who needs equity anyway?

- And still another: Are liabilities now assets?

Last week, Howard Marks delivered his latest memo. In what he describes as a break with precedent, he chose the topic based not on "a series of events [that] can be interestingly juxtaposed," but on "a request."
According to Marks, a colleague (Ian Schapiro, who leads Oaktree’s Power Opportunities group) suggested Howard write something about negative rates.
Howard's knee-jerk reaction (which he calls "immediate and unequivocal") was that such a request wasn't doable because when it comes to negative rates, "I don’t know anything about them."
After thinking about it, Marks realized that was precisely the point. Nobody knows anything about negative rates - not really, anyway.
And so, Marks essentially set about expounding on a collection of quotables and media clippings he says he's been "saving up." There's nothing particularly profound about Howard's latest (dated October 17), but, again, he makes no claims to profundity.
I wasn't going to cover Marks's negative rates memo, but ultimately, I did in a note published elsewhere last weekend. Since then, I've found myself revisiting Howard's piece on a couple of occasions, most recently on Friday evening, when one of the few remaining friends I have left called to ask me how I would approach teaching an entry-level finance course to undergraduates in light of the post-crisis monetary policy regime.
My initial response was that you really can't. Not unless you want to divide things into two sections – the way things used to be versus the way things are now; pre-crisis versus post-crisis, B.C. and Anno Domini (to quote something I penned earlier this month).

My friend sent me a link to an open-source finance text she intended to use, and I quickly realized that every, single chapter would have to be totally rewritten, or amended with footnotes and caveats at every turn if she hoped to somehow bridge the gap between how things used to work and how things work now, after a decade of QE and the proliferation of negative rates and other adventures in monetary Wonderland.
Ultimately, I recommended teaching the course by the book, and then assigning a series of recent academic journal articles as addenda near the end of the semester. I also suggested Marks's memo might be a good way to help folks transition from the old way of thinking about things to the post-crisis reality which, in many respects, is simply a fun house mirror image - a distorted reflection of the old rules.
One of the starkest examples of a world flipped upside down is the proliferation of negative-yielding corporate bonds. This is something I've discussed in these pages on several occasions, and elsewhere ad nauseam. Marks brings it up in his October 17 memo.
"How will the markets value businesses that hold cash versus those that are deep in debt?" Howard wonders.
Another way to frame the question is: How do things change when negative rates effectively convert liabilities into assets? Or, to quote Marks again: "If having negative-yield debt outstanding becomes a source of income, will levered companies be considered more creditworthy?"
I'm going to quote/paraphrase myself a bit in the next couple of paragraphs, so if some of the language sounds familiar, that's why.
It's important to remember that negative-yielding corporate debt isn’t so "anomalous" anymore – at least not across the pond. In other words, Marks isn't idly speculating about some quaint curiosity. At one point in late August, when yields plunged across the globe, more than €1 trillion of European corporate bonds sported yields less than zero.
That, BofA marveled at the time, was half of the entire € investment grade corporate credit market.
At one point this summer, there were 100 different issuers in the € debt market whose entire curve was negative.

In a sense, those corporates can essentially mint assets. Naturally, that would incentivize issuance.
"The risk is that companies begin to view negative yielding debt more as an ‘asset’ going forward, rather than a ‘liability’ and hence issue more of it," BofA’s Barnaby Martin wrote over the summer.
Marks echoed that last week. "Traditionally, markets have penalized heavily levered companies and rewarded those that are cash-rich."
But what happens when debt is an asset and cash is a liability? After all, if negative rates end up being passed along to corporate cash piles, that cash has a negative carry. Either it "earns" a negative yield on deposit, or you pay to store it somewhere, which is, in effect, the same thing (the cost of storage is essentially a tax).
Obviously, companies with massive cash balances would, in many cases, be healthy businesses and those which are highly-levered, not so much, so it's not as simple as saying "the more debt the better" in a world where the old rules no longer apply. But, this is an important discussion to have, because it raises very real questions about how to value companies which fall somewhere in the middle.

That is, what about a situation where two generally healthy companies are juxtaposed, and one chooses to opportunistically take on debt in a hypothetical environment of deeply negative corporate bond yields, while the other insists on holding a lot of cash on deposit when rates are negative?
The leveraged company isn't taking on the debt because they necessarily need to, but rather because in a world where the rules are upside down, it's the "right" thing to do.
If both businesses are thriving, which of those companies should command a premium? Or, as Marks puts it, "How will the market value businesses that hold a lot of cash and thus have to pay banks to keep it on deposit?"
Now you might be asking yourself: Ok, Heisenberg, but isn't this all just a thought experiment?
No. No, it is not. Because as noted above, this is the reality in Europe, and it's likely to become more "norm" than "exception" in other locales going forward, as central banks restart asset purchases and begin cutting rates anew.

The chart in the left pane below shows that policymakers are now cutting rates at an even faster clip than the trend in realized inflation dictates. The chart on the right shows that "peak" Quantitative Tightening has long since passed.
Take a minute to consider what this means for how corporates finance themselves. As the above-mentioned Barnaby Martin writes in a note dated Friday, "the gap between equity and debt costs in Europe is at a 100-year high."
Clearly, that suggests that the trend of "de-equitization" is likely to continue. That is, the number of publicly-listed companies will almost surely shrink.
Indeed, over the post-crisis period, the number of EU-listed companies has collapsed by 25% from more than 10,000 to roughly 8,000 as EU central bank balance sheets have grown.
If you're wondering whether a similar relationship shows up if you plot the number of EU-listed companies with the average bank lending rate to non-financial corporates and the average effective yield on € IG credit, the answer is "yes."
At the same time, the global store of private capital "dry powder" has exploded to more than $2 trillion amid the hunt for yield. As BofA's Martin goes on to write in the same cited note, "while Private Equity accounted for a shrinking proportion of dry powder between 2006-2013, PE now accounts for almost 60% of available dry powder, the largest proportion observed since 2012." That could potentially accelerate the de-equitization process if management and shareholders decide to go the PE route.

All of this has two obvious consequences.

First, credit markets will continue to expand, and that brings risk. The more forgiving the debt market, the more tempting it will be, and as you might imagine, debut issuers across buckets within IG tend to be more highly-levered than their established counterparts.
Perhaps even more importantly, BofA notes the following about the perils of a less "real-time" (as it were) market:
We think the long-term consequence of de-equitization is that markets will be less able to assess the real-time state of the economy. Fewer listed companies mean fewer disclosures about how earnings are faring, how business segments are performing, how geographical earnings splits are evolving… and ultimately, fewer disclosures about emerging risks. And if there is a less reliable pulse on the economy, then this could impart more volatility to the consensus trades of the future, as markets suddenly realize that the "facts have changed."
When you throw in the cross-asset trend of deteriorating liquidity, you're left to ponder a world where investors are increasingly forced to fumble around in the dark.
And that brings us back full circle to Marks's memo and my friend who is facing the unenviable task of trying to explain some of these upside down dynamics to undergraduates.

We're all fumbling around in the dark.
Or, as Howard puts it, "I’m convinced that no one should be categorical about how to deal with a mystery like this in such unprecedented and confusing circumstances."

Extraordinary Monetary Disorder

Doug Nolan

M2 money supply has increased $796 billion y-t-d to $15.245 TN. With two months to go, 2019 M2 growth is on track to easily exceed 2016’s record $854 billion expansion. Recent M2 growth is nothing short of spectacular. M2 has jumped $329 billion in ten weeks, about an 11.5% annualized pace. Over 26 weeks, M2 surged $677 billion, or 9.3% annualized. One must go all the way back to the restart of QE in late 2012 to see a comparable surge in the money supply. Since the end of 2008, M2 has inflated $7.027 TN, or 86%.

Money Market Fund Assets (MMFA) have similarly exploded this year. Total MMFA have increased $517 billion year-to-date (to $3.555 TN), an almost 20% annualized rate. Like M2, six-month growth in MMFA has been extraordinary: expansion of $472 billion, or 35% annualized.

With MMFA at the highest level since 2009, bullish market pundits salivate at the thought of a wall of liquidity coming out of cash holdings to chase a surging equities marketplace. A Tuesday Wall Street Journal article (Ira Iosebashvili) is typical: “Ready to Boost Stocks: Investors’ Multitrillion Cash Hoard: Nervous investors have socked $3.4 trillion away in cash.
But stocks are rising and their nerves are calming, leading bulls to view the huge cash pile as a sign that markets have room to go higher.”

And while MMFA are back to the 2009 level, it is worth pondering that money fund growth hasn’t been this robust since 2007. After ending April 2006 at $2.031 TN, money fund assets began growing rapidly, ending 2006 at $2.382 TN. And after expanding $154 billion, or 13% annualized, during 2007’s first-half, things went a little haywire. MMFA proceeded to surge $1.000 TN, or 53% annualized, over the next nine months.

Recall that subprime erupted in the summer of 2007, with equities stumbling before regaining composure to trade to all-time highs in October.

August 17, 2007: The FOMC’s extraordinary inter-meeting policy adjustment: “To promote the restoration of orderly conditions in financial markets, the Federal Reserve Board approved temporary changes to its primary credit discount window facility. The Board approved a 50 bps reduction in the primary credit rate to 5-3/4%…” The FOMC then cut Fed funds 50 bps on September 18th, then another 25 bps both on October 31st and December 11th. The FOMC then slashed rates 75 bps in an unscheduled meeting on January 22, 2008, and another 50 bps on January 30th and another 75 bps on March 18th (to 2.00%).

Conventional thinking has it that market instability and risk aversion were behind the surge in MMFA. Yet there was also a notable acceleration of M2 money supply growth. After expanding at a 5.5% rate during 2007’s first-half, money supply growth surged to a 7.1% pace over the subsequent nine months.

2007 was a period of Extraordinary Monetary Disorder that manifested into acute market instability.

Despite the dislocation that engulfed high-risk mortgage finance, Wall Street finance was “still dancing” right through the summer of 2007. Not only did stock prices ignore subprime ramifications, crude oil prices went on a moonshot – surging from about $70 mid-year to a high of $96 in November. After trading as low as 161 in August, the Bloomberg Commodities Index surged as much as 15% to trade to 186 in November. By June 2008, Monetary Disorder saw crude spike above $140, with the Bloomberg Commodities index almost reaching 240.

My long-held view is the Fed’s aggressive monetary stimulus in 2007 was a major contributor to late-cycle “Terminal Phase Excess” – and resulting Extraordinary Monetary Disorder - that came home to roost during the 2008 crisis. After trading as high as 5.30% in early June 2007, ten-year Treasury yields were 100 bps lower just three months later. Ten-year yields ended 2007 just above 4.00% and were as low as 3.31% by mid-March – a full 200 bps below yields from nine months earlier.

I believe a surge in speculative leverage played an instrumental role in the expansion of marketplace liquidity – that flowed into a rapid expansion of MMFA as well as M2 money supply. It’s worth noting the Fed’s Z.1 “Fed Funds and Repo” category posted Extraordinary growth during this period. After ending 2006 at $3.858 TN, “repos” increased $799 billion over five quarters to $4.657 TN (end of Q1 ’08).

Wall Street was indeed “still dancing” hard through the end of 2007. The Fed moved to bolster the economy in the face of heightened financial instability. The impact of stimulus measures on the real economy is debatable. My own view is that late-cycle stimulus is problematic, as it tends to stoke already overheated sectors and exacerbate imbalances and maladjustment. The impact of stimulus on finance should be indisputable. The upshot of deploying stimulus in a backdrop of market speculation is dangerous speculative Bubbles.

With the enormous growth of M2 and MMFA during 2007 and into 2008, how was it possible for markets to turn disastrously illiquid in the fall of 2008? Because the monetary expansion was being fueled by a precarious expansion of the “repo” market and securities speculative finance more generally.

While markets – Treasuries, corporate Credit, equities, crude and commodities – were being driven by what appeared sustainable liquidity abundance, the source of this underlying monetary stimulus was acutely unstable speculative leveraging. And as the Fed cut rates, yields collapsed, stocks shot skyward and commodities went on a moonshot, the self-reinforcing nature of speculative excess (and leverage) fomenting acute Monetary Disorder.

Speculative blow-offs are a late-cycle phenomenon. Over the course of a boom cycle, financial innovation gathers momentum. The most aggressive risk-takers have proved the most successful, in the process attracting huge assets under management. The laggards come under intense pressure to chase performance with riskier portfolios. Out of necessity, caution is thrown to the wind.

Between new instruments, products and strategies, market structure adapts to an environment of heightened risk-taking and leverage.

In short, a speculative marketplace takes on a strong inflationary bias (upward price impulses).

In such a backdrop, central bank monetary stimulus is extraordinarily potent – perhaps not so much for a late-cycle economic cycle, yet remarkably so for a ripened speculative cycle susceptible to “melt-up” dynamics.

I have posited that late-cycle dynamics turn increasingly precarious due to the widening divergence between a faltering economic Bubble and runaway speculative market Bubbles.

This was certainly the case in the second-half of 2007 and into 2008. I believe this dynamic has been more powerful, more global and much more problematic over the past year.

The Shanghai Composite is up 18.9% y-t-d, the CSI 300 32.0% and the ChiNext index 36.8%, despite economic deterioration and heightened risk. Chinese apartment prices continue to inflate a double-digit rates, as ongoing rapid Credit growth increasingly feeds asset inflation as the real economy struggles. Germany’s DAX equities index enjoys a 2019 gain of 25.3%, France’s CAC40 24.5% and Italy’s MIB 28.4%, in the face of economic stagnation.

ECB stimulus measures have fueled a historic bond market Bubble and formidable equities Bubble, while the real economy barely treads water. Stocks in Russia are up 25.5%, Brazil 22.5%, Taiwan 19.0% and Turkey 13.0%, as EM keys off booming global liquidity excess while disregarding mounting risks. Here at home, the S&P500 has gained 23.4%, the Nasdaq Composite 27.7% and the Semiconductors 50.4%, as the Fed’s “insurance” rate cuts stoke speculative excess.

By the time the collapsing mortgage finance Bubble finally (after several close calls) triggered a run on Lehman money market liabilities (inciting major deleveraging), the system was acutely fragile. “Blow-off” speculative excess had stoked inflation across the asset markets, price distortions increasingly vulnerable to any interruption in the flow of market liquidity. Yet it went much beyond interruption, as the abrupt reversal of speculative leverage caused a collapse in market liquidity.

I believe 2007’s excesses - spurred by Fed stimulus measures that fueled speculative “blow-offs” and gaping divergences between market Bubbles and the vulnerable real economy – sowed the seeds for an unavoidable crisis. Rate cuts only exacerbated late-cycle excess and worsened financial and economic dislocations.

I have that same uncomfortable feeling I had in 2007 – just a lot worse. The global financial system is self-destructing. Reckless monetary policies have inflamed late-cycle excess. I believe the scope of speculative leverage is much greater these days – on a global basis. The Fed in 2007 (and into ’08) extended a dangerous mortgage finance Bubble.

Central bankers these days are prolonging catastrophic global financial and economic Bubbles.

The global economy is much more fragile today, with a faltering Chinese Bubble posing an Extraordinary risk. Highly synchronized global financial Bubbles are a risk much beyond 2008.

Moreover, central bankers have used precious resources to sustain Bubbles, ensuring much greater fragilities will be countered by limited policy capabilities.

We will now await the catalyst for an inevitable bout of de-risking/deleveraging.

There could be a few Lehmans lurking out there – in Asia if I was placing odds. China remains an accident in the making, with another ominous week in Chinese Credit (see “China Watch”).

And near the top of my list of possible catalysts would be a surge in global yields. Sinking bond prices are problematic for highly leveraged holdings. Indeed, it is no coincidence that “repo” market issues erupted the week following a sharp reversal in market yields.

It was a notably rough week for global bond markets. Ten-year Treasury yields surged 23 bps to 1.91% (high since July 31). German bund yields rose 12 bps to negative 0.26% (high since July 12). Japanese yields jumped 13 bps to negative 0.05% (high since May 22). Italian yields surged 20 bps to 1.19%, and Greek yields rose 13 bps to 1.30%. Brazilian (real) 10-year yields surged 30 bps. Eastern European bonds, in particular, were under heavy selling pressure.

It’s worth noting bond prices are down sharply since last week’s Fed rate cut. Meanwhile, stock prices have continued to melt up. One could similarly argue that the expanding Fed balance sheet has been benefiting equities - bonds not so much. In general, monetary stimulus tends to inflate the asset class with the strongest inflationary bias.

Bond prices peaked two months ago. And bonds have good reason to fret aggressive global monetary stimulus. Booming stock markets and resulting loose financial conditions underpin growth and inflationary pressures.

November 9 – Bloomberg: “China’s consumer inflation rose to a seven-year high last month on the back of rising pork prices, complicating policy makers’ decision on whether to further ease funding for the country’s weakening industrial sector. The consumer price index rose 3.8% in October from a year earlier, up from 3% in the previous month.”

A negative print (down 0.3%) for Q3 Nonfarm Productivity and Unit Labor Costs up 3.6% are supportive of inflationary pressures here in the U.S. But it’s massive supply as far as the eye can see that must have the Treasury market on edge. The uncomfortable reality of a highly levered marketplace, with downward pressure on prices and fiscal deficits approaching 5% of GDP.

Yet negative fundamentals can be ignored so long as China’s Bubbles are about to implode. But with a trade deal somewhat postponing China’s day of reckoning – while holding additional global monetary stimulus at bay – the bond market risk versus reward calculus loses much of its appeal.

It’s possible that a de-risking/deleveraging cycle commenced in early-September. The Fed’s eight-week $270 billion balance sheet expansion accommodated some deleveraging. But at some point the Fed will apparently settle into $60 billion monthly T-bill purchases – that won’t be much help in a de-risking environment. Stocks are fired up at the prospect of a year-end melt-up.

The surprise would be a global bond market beat down – the downside of Extraordinary Monetary Disorder.


The deep appeal of emerging markets is their lack of surface appeal

They are less at risk of a surfeit of sellers over buyers

BILL HICKS, a much-mourned comedian, would pause in the middle of his act as if a thought had just occurred to him. He would ask that anyone in the audience who worked in advertising or marketing kill themselves. This was the only path to redemption now left open. No one took up his invitation.

I know what the marketing people are thinking, he would then say. The anti-marketing dollar, that’s a good market. Look at our research! Bill is smart to tap into it.

Such next-level thinking comes to mind whenever the case for emerging markets is considered.

For professional investors, diverting capital from America’s stockmarket to other less-blessed places seems like an invitation to career suicide.

The dollar’s continued strength is kryptonite to emerging markets. They feel the damage from the trade war most keenly. Sure, emerging markets look cheap. But there is no law saying they cannot become even cheaper.

Cheapness aside, though, there is another, less appreciated, side to emerging markets. As capital rushes into an ever narrower set of favoured rich-country assets, there is growing anxiety that it might all suddenly unwind. At least emerging markets are an uncrowded trade.

This is a paradox that tricksy marketing types should appreciate: the unloved asset class, that’s a good market. You might be wise to tap into it.

But why are emerging markets out of favour in the first place? The perennial fear is they are crisis-prone. Look at Argentina. It has moved with breathtaking speed from default to emerging-market darling and then—unhindered by a $57bn IMF support package—back to the brink of default. But fear of crises is not the only reason for caution.

Indices of emerging-market stocks, such as MSCI’s benchmark, lean heavily towards Factory Asia, and thus to China’s supply chain. This puts investors on the front line of the trade war.

Even away from the trenches, there is plenty to fret about. India has failed to fix its broken banks. The fractious politics of the ANC in South Africa get in the way of much-needed reforms. Russia lacks a convincing economic-growth story. The list goes on.

Emerging-market crises follow a pattern. Foreign investors head for the exit, and there are not enough domestic buyers to replace them. Some factors can make this kind of liquidity-driven crisis more likely: a bloated current-account deficit; an overvalued currency; lots of short-term debt; or runaway inflation. But these days, such vulnerabilities have become rare.

The bigger emerging markets tend to have freely floating currencies. This militates against the build-up of external debts and internal pressures. Their independent central banks aim for low inflation. Most of the 25 emerging markets listed on the indicators page of The Economist have inflation below 4%. It is in the double digits in only two—Argentina and Pakistan.

Low and stable inflation has allowed the local market for government bonds to deepen. Debt burdens financed at short maturities make countries more crisis-prone. Long-term debt makes them more stable.

According to the IMF, the average emerging market has public debt of 54% of GDP, around half the rich-country norm. The average maturity of debt is similar, at around seven years.

All this has made emerging markets much less brittle. Yet assets trade at a discount. The price-to-earnings ratio for the MSCI index of emerging-market stocks is below its average since the mid-1990s. It looks even better value when compared to that in the rich world. The S&P 500 share-price index has only rarely been dearer relative to emerging-market stocks than it is now (see chart).

You should expect out-of-favour markets to be cheap. But they also have a less appreciated appeal. They tend to be uncrowded, and so less at risk of a sudden surfeit of sellers over buyers.

If liquidity risk has fallen in emerging markets, it has probably risen in developed ones. The worry is that investors are chasing the same assets: the safest government bonds; investment-grade corporate bonds; technology stocks; and dollar assets in general.

The more investors cram into these markets, the greater the risk of a rush to the exit.

An allocation to unloved assets insures against such herding. It is hard to drum up much enthusiasm for the leadership or growth trajectories of China, India, Russia and the rest. There are few if any captivating stories of reform and renewal.

But the appeal of emerging markets is in their very lack of superficial appeal. Some bright marketing spark should put that on a billboard.

No Art to the US-China Trade Deal

The real problem with the phase one accord announced on October 11 is the basic structure of the deal into which it presumably fits. From trade to currency, the approach is the same – prescribing bilateral remedies for multilateral problems.

Stephen S. Roach


NEW HAVEN – Dealmakers always know when to cut their losses. And so it is with the self-proclaimed greatest dealmaker of them all: US President Donald Trump. Having promised a Grand Deal with China, the 13th round of bilateral trade negotiations ended on October 11 with barely a whimper, yielding a watered-down partial agreement: the “phase one” Accord.

This wasn’t supposed to happen. The Trump administration’s three-pronged negotiating strategy has long featured a major reduction in the bilateral trade deficit, a conflict-resolution framework to address problems ranging from alleged intellectual-property theft and forced technology transfer to services reforms and so-called non-tariff barriers, along with a tough enforcement mechanism. According to one of the lead US negotiators, Treasury Secretary Steven Mnuchin, the Grand Deal was about 90% done in June, before it all unraveled in a contentious blame game and a further escalation of tit-for-tat tariffs.

But hope springs eternal. As both economies started to show visible signs of distress, there was new optimism that reason would finally prevail, even in the face of an escalating weaponization of policy by the United States: threatened capital controls, rumored delisting of Chinese companies whose shares trade on American stock exchanges, new visa restrictions, a sharp expansion of blacklisted Chinese firms on the dreaded Entity List, and talk of congressional passage of the Hong Kong Human Rights and Democracy Act of 2019. Financial markets looked the other way and soared in anticipation in the days leading up to the October 11 announcement.

And yet the phase one deal announced with great fanfare is a huge disappointment. For starters, there is no codified agreement or clarity on enforcement. There is only a vague promise to clarify in the coming weeks Chinese intentions to purchase about $40-50 billion worth of US agricultural products, a nod in the direction of a relatively meaningless agreement on currency manipulation, and some hints of initiatives on IP protection and financial-sector liberalization. And for that, the Chinese get a major concession: a second reprieve on a new round of tariffs on exports to the US worth some $250 billion that was initially supposed to take effect on October 1.

Far from a breakthrough, these loose commitments, like comparable earlier promises, offer little of substance. For years, China has long embraced the “fat-wallet” approach when it comes to defusing trade tensions with the US. In the past, that meant boosting imports of American aircraft; today, it means buying more soybeans. Of course, it has an even longer shopping list of US-made products, especially those tied to telecommunications equipment maker Huawei’s technology supply chain.

But China’s open wallet won’t solve America’s far deeper economic problems.

The $879 billion US merchandise trade deficit in 2018 (running at $919 billion in the second quarter of 2019) reflects trade imbalances with 102 countries.

This is a multilateral problem, not the China-centric bilateral problem that politicians insist must be addressed in order to assuage all that ails American manufacturers and workers.

Yet without resolving the macroeconomic imbalances that underpin this multilateral trade deficit – namely, a chronic shortfall of domestic saving – all a China fix could accomplish would be a diversion of trade to higher-cost foreign producers, which would be the functional equivalent of a tax hike on US consumers.

Promises of a currency agreement are equally suspicious. This is an easy, but unnecessary, add-on to any deal. While the renminbi’s exchange rate against the US dollar has fallen by 11% since the trade war commenced in March 2018, it is up 46% in inflation-adjusted terms against a broad constellation of China’s trading partners since the end of 2004. Like trade, currencies must be assessed from a multilateral perspective to judge whether a country is manipulating its exchange rate to gain an unfair competitive advantage.

That assessment makes it quite clear that China does not meet the widely accepted criteria for currency manipulation. Its once-outsize current-account surplus has all but disappeared, and there is no evidence of any overt official intervention in foreign-exchange markets. In August, the International Monetary Fund reaffirmed that very conclusion in its so-called Article IV review of China. Although the US Treasury recently deemed China guilty of currency manipulation, this verdict was at odds with the Treasury’s own criteria, and Mnuchin is now hinting that it may be reversed. Far from essential, a new currency agreement is nothing more than a feeble grab for political bragging rights.

The real problem with the phase one accord is the basic structure of the deal into which it presumably fits. From trade to currency, the approach is the same – prescribing bilateral remedies for multilateral problems. That won’t work. Multilateral problems require solutions aimed at the macroeconomic imbalances on which they rest. That could mean a reciprocal market-opening framework like a bilateral investment treaty or a rebalancing of saving disparities between the two countries that occupy the extremes on the saving spectrum.

The saving issue is especially critical for the US. America’s net domestic saving rate of just 2.2% of national income in the second quarter of 2019 is far short of the 6.3% average in the final three decades of the twentieth century. Boosting saving – precisely the opposite of what the US is doing in light of the ominous trajectory of its budget deficit – would be the most effective means by far to reduce America’s multilateral trade imbalance with China and 101 other countries. Doing so would also take the misdirected focus off a bilateral assessment of the dollar in a multilateral world.

A macro perspective is always tough for politicians. That is especially true today in the US, because it doesn’t fit neatly with xenophobic bilateral fixations, like China bashing. With new signs of Chinese resistance now surfacing, the phase one accord may never see the light of day.

But if it does, it will hurt more than it helps in addressing one of the world’s toughest current economic problems.

Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China.

Thatcher’s fear of an overmighty Germany lives on in Brexit

Thirty years after the Berlin Wall fell, the power balance in the EU is being upended again

Philip Stephens

web_Thatcher and German re-unification
© Ingram Pinn/Financial Times

Thirty years ago, at one of the hinge points of European history, Margaret Thatcher tipped up at the Kremlin for talks with Mikhail Gorbachev. Britain’s prime minister had once described the Soviet president as someone with whom she could “do business”.

Now, the foundations of Soviet communism were cracking. Hungary had torn down the barbed wire at its border. East Germans were fleeing westwards. The fall of the Berlin Wall was only weeks away.

For journalists travelling with Thatcher, the visit was memorable for more trivial reasons. After a rapid-fire Japanese tour, the prime minister’s party arrived on a gruelling flight from Tokyo. Thatcher travelled on one of the Royal Air Force’s ageing VC-10s. Decades earlier the aircraft had been at aviation’s cutting edge; by the standards of 1989, it was uncomfortable, noisy and, for those squeezed into the back, claustrophobic.

Its limited range meant a refuelling stop at a military air base in bleakest Siberia, where two burly Soviet air force officers joined the party. Were they spies or chaperones? Either way, they would surely report back that the top secret communications equipment carried on the flight resembled nothing so much as a collection of vintage valve radios.

Thatcher had spent a lifetime fighting communism — at one with her great friend US president Ronald Reagan in condemning the Berlin Wall as a shameful barrier to freedom. A year earlier, in a speech in Bruges, she had spoken eloquently of a Europe of democracies that also embraced Prague, Warsaw and Budapest. History was turning her way.

Yet even as the Soviet empire began to unravel, the Iron Lady was having second thoughts. During a long, private encounter in the Kremlin’s St Catherine Hall, Thatcher offered Mr Gorbachev what seems now an unimaginable pledge. “We do not want the unification of Germany,” she said. “It would lead to changes in the postwar borders that . . . [would] undermine the stability of the entire international situation.” Mr Gorbachev should ignore any Nato statements suggesting otherwise. The alliance would not spur the collapse of the Warsaw Pact or indeed the “de-communisation” of eastern Europe.

This was explosive stuff. The note-takers had been told to put down their pens. Mr Gorbachev’s adviser Anatoly Chernyaev, however, wrote a lengthy account when the meeting ended. A shorter version, authored by Thatcher’s aide Charles Powell, reached just a handful of people in Whitehall.

Thatcher’s démarche was a product of personal neuralgia. She never let go of the deep suspicion of Germany shared by many of her generation on the right of the Conservative party.

Had the Germans really changed? Wasn’t aggressive expansionism part of the national character? A year later she sacked the Eurosceptic minister Nicholas Ridley after he compared EU plans for a single currency with Adolf Hitler’s ambitions.  In truth, she agreed with him.
Some others in Europe shared her fears. The cold war stand-off with the Soviet Union had provided a curious stability. When Thatcher met French president François Mitterrand in December 1989 there was talk of a new entente cordiale to contain German power. But Mitterrand soon understood that the genie was out of the bottle. Britain might try to block or delay unification, but France would seek instead to lock a united Germany into a more integrated Europe through the creation of a single currency.

Thirty years later, the postwar transformation of Germany — its firm embrace of pacifism and commitments to democracy and a rules-based international order — still goes unnoticed across a large swath of the Brexit-supporting Conservative party. Boris Johnson struggles to resist parallels between the ambitions of the EU and those of Nazi Germany. The euro is hegemony by another means. The prime minister’s language, and that of his fellow Brexiters, is shot through with imagery — standing alone, surrender, collaborator and traitor — calculated to summon up the second world war.

As it happens, unification did indeed mark the return of the German question — in the simple sense that Germany’s preponderant economic power is once again an unavoidable fact of life. What the Brexiters miss is that the EU was designed as a strong countervailing force. The US security guarantee embedded in Nato serves the same purpose — underpinning the democratic foundations of a European Germany in place of a German Europe.

Brexit upends the big-power balance within the EU. France finds itself alone as a counterpoint to Germany. This at a time when US president Donald Trump is doing his best to weaken Nato. A charitable interpretation of Thatcher’s performance in Moscow would say she wanted to preserve the security offered by the status quo. Brexit marches in the opposite direction. If there is any risk of an over-mighty Germany it lies in the collapse of the present European order.

On the VC10’s flight back to London the journalists joined Thatcher in her more spacious, if scarcely luxurious, quarters. For the only time I can recall on such a trip, she asked the RAF stewards to break out champagne. Then she waxed lyrical about Mr Gorbachev’s great courage in pressing ahead with perestroika and glasnost. Not a whisper was heard of a plan that would have denied East Germans their freedom.