Paris Soloist

Macron Plays Fox in the EU Hen House

French President Emmanuel Macron has a grand foreign policy vision for Europe and he has been energetically pushing it forward. In the process, though, he has angered Germany and other European Union allies.

French President Emmanuel Macron
French President Emmanuel Macron


With a microphone in his right hand, his left shoved casually into his pocket, French President Emmanuel Macron was standing on the stage inside a former slaughterhouse in Paris, turning from side to side to address his entire audience. And it was quite an audience. United Nations Secretary-General António Guterres was there, as was future European Commission President Ursula von der Leyen, German Foreign Minister Heiko Maas, the president of the Democratic Republic of the Congo and other leading politicians.

It was Tuesday morning of this week and Macron was holding the opening address at the Paris Peace Forum, a two-day event aiming to bring together some of the major actors on the world stage. It's an invention of the French government, a typically ambitious Macron project.

Macron spoke for 22 minutes about hegemony and colonialism, about World War I and the fall of the Berlin Wall. In closing, he quoted the recently deceased Hungarian philosopher Ágnes Heller, who said, in Macron's telling, that more than ever, a certain amount of heroism is needed to provide answers to the present. Looking away in cowardice, remaining stuck in old habits and doing nothing, Macron continued, is not an option for all those who have been handed a political mandate by the electorate.

The message Macron was trying to send by quoting the Hungarian intellectual was relatively clear. I, Emmanuel Macron, he seemed to be saying, did nothing more in my widely criticized interview with the Economist than take a fresh look at our crisis-ridden present and draw my own conclusions. Part of that exercise was casting doubt on NATO's functionality and on the readiness of the Germans to work toward establishing a strong, sovereign Europe.

Rarely has an interview triggered as much consternation in Europe as Macron's sit-down with the Economist, which hit the newsstands last Thursday. In the piece, the French president posited that NATO has suffered from "brain death," questioned whether NATO's Article Five is still functional and warned of a possibly apocalyptic future for Europe.

'This Isn't It'

Allegedly, say sources in Paris, the French Foreign Ministry was only informed of the content of Macron's interview with the Economist 48 hours before it was published. Berlin, meanwhile, was blindsided. Ahead of Macron's famous 2017 speech at the Sorbonne, where he laid out far-reaching proposals for the EU's future, German Chancellor Angela Merkel had received an advance copy. But on this occasion, she was caught unawares.

"You always have to ask how trust develops," said one German diplomat. "This isn't it."

Still, the German government very much shares Macron's doubts about the effectiveness of the trans-Atlantic alliance. But calling Article Five into question, NATO's foundational article that requires all alliance members to help out if one member is attacked, is something one would tend to expect more from someone like U.S. President Donald Trump.

Foreign Minister Heiko Maas is concerned that the current NATO discussion could end up dividing Europe. Eastern Europeans, in particular, feel as though the French president is completely ignoring their concerns. "In addition, they all, of course, assume that his comments were coordinated with us, which was not the case," Maas says. He went on to say that the upcoming 70th anniversary celebrations for NATO, set to take place in early December in London, must now be extremely well-prepared.

In Brussels, too, understanding for Macron's comments is limited, though that's not necessarily due to his analysis, which is shared by many in the EU capital. "Emmanuel Macron is right about 95 percent of what he said," says Luxembourg Foreign Minister Jean Asselborn. "But the existence of NATO as a military alliance is not up for debate."

Macron has no fear of taboos. The path that ended with his installment in Élysée Palace in May 2017 ran counter to all the rules of French politics. For the first time since 1958, the French elected a president who did not belong to one of the established political parties. Macron found success precisely because he didn't conform to existing structures, and that remains his key political achievement to this day.

A Man of Convictions

It also explains why he saw fit to act like the fox in Europe's henhouse without informing his German partners first. He is hoping that the shock value of his comments will set change in motion, and that someone else will clean up after him. Macron, the ambitious elite-school product, is also a gambler. And a man of convictions.

That became apparent as early as 2017, when he challenged the EU to awake out of its stagnant slumber. Since then, he has been waiting in vain for an adequate response from Berlin to his many proposals for the reform of the EU. Last week, Macron transformed that 2017 wakeup call into a shrill alarm, in part out of his firmly held conviction that there is very little time remaining to save the EU.

Inside the German Foreign Ministry -- led, as it is, by the Social Democrat Maas -- is where one can find the most understanding for Macron's impatience, given the prevailing feeling there that the chancellor never really provided an adequate response to the French president's reform proposals. Nevertheless, there is a widespread feeling inside the ministry that Macron's decision to go solo is rather un-European.

"I think it is legitimate to launch such discussions," Maas says, "even if I might not agree with his choice of words. But in the German-French relationship, we need to aim for unity when it comes to our strategic approach so that no lasting damage is done."

Over in the Chancellery, there is frustration at the fact that the German government is consistently depicted as being hesitant while it's always Macron with the bold ideas. "We have moved significantly on a number of issues, and then we read that the German position on the eurozone is untenable," says one government adviser. "Thanks a ton."

Essentially, there is something of a paradox in the current German-French relationship. On the one hand, the two countries have made great strides in a number of areas over the last two-and-a-half years. In summer 2017, they agreed on the development of a joint fighter jet and proposed a joint European defense fund. In the next five years, the European Stability Mechanism, the permanent euro backstop fund, is to be financed to the tune of more than 55 billion euros. And German Finance Minister Olaf Scholz just recently presented his plans for an EU-wide deposit insurance scheme.

Determination, Energy and Fearlessness

On the other hand, though, Berlin and Paris have proven unable to sell joint projects as successes.

Another aspect of the paradox is the fact that Macron is still quite well-liked by the Germans. His determination, energy and fearlessness continue to impress politicians in Berlin. At the same time, though, the German government has never been able to muster the courage to throw its weight behind Macron's EU vision. And now, after more than two years of waiting, the constant stream of Macron's solo initiative has led German diplomats -- not normally known for public displays of emotion -- to lose their composure. They see 2019 as a year in which Macron has stood in the way on many issues and isolated himself with his demands.

A NATO exercise in Latvia in February
A NATO exercise in Latvia in February


The Franco-German discord began in early February, when France suddenly and without warning joined the side of those opposed to the construction of the natural gas pipeline Nord Stream 2. German negotiators were taken by surprise and France's flip-flop meant that there was suddenly an EU majority in favor of new natural gas rules that would have made it more difficult to complete the project. It would also have handed the European Commission the opportunity to place new hurdles in the way of the controversial project. A compromise was only found at the last minute.

Mistrust between Paris and Berlin then grew at the end of February when it came to the question as to how the EU should position itself in the trade tiff with U.S. President Donald Trump. Whereas Berlin was eager to give European Trade Commissioner Cecilia Malmstrom a negotiating mandate to ward off looming tariffs on automobile imports from Europe, Paris was in no hurry at all. With European Parliament elections on the horizon, the French were keen to avoid giving the impression that a trade conflict with the U.S. could also involve agricultural products and negatively affect French farmers.

French diplomats in Brussels are open about the fact that differences between Berlin and Paris are growing more frequent. Berlin officials, by contrast, insist that the frontlines now run between Paris and the rest of the EU. That has also been easy to see when it comes to Brexit. In recent months, Macron has repeatedly failed in his demand that Britain not be granted a deferral or, if unavoidable, merely a short delay. Most recently, the French had virtually no allies left on the issue.

A 'Historic Mistake'

Macron was similarly isolated at the EU summit in mid-October, when he blocked the beginning of accession negotiations with North Macedonia by making use of his veto. Outgoing Commission President Jean-Claude Juncker referred to it as a "historic mistake" that could endanger the Balkan country's stability. Merkel likewise said pointedly that the EU had to "remain reliable."

Insiders say that it only became clear how Macron would vote on the issue just one day before EU heads of state and government gathered for the summit. When Chancellery staff inquire at the Élysée as to why they aren't always kept informed, they sometimes receive answers that they have thus far only associated with the Trump administration in Washington: Élysée staff, they hear, only has limited influence over the president.

In August, Macron initiated a new approach to Russia without consulting at all with his allies. Just a few days ahead of the G-7 summit in Biarritz, a group that Russia was expelled from after the annexation of the Crimea, Macron invited Russian President Vladimir Putin to southern France for talks.

Not speaking with Russia would be a major mistake, Macron said immediately before the consultations. Russia, he said, is part of Europe and it cannot and should not be ignored, adding that he believed in the power of geography and European history. Even then, it was growing clear that Macron was thinking about a new security concept for Europe.

For Macron, a strong Europe is one that self-confidently seeks dialogue with the large and mid-sized powers the world over. The more we do to ensure that Russia becomes a power within Europe, Macron said at the time, the better. Shortly after the summit, Macron sent French Foreign Minister Jean-Yves Le Drian and Defense Minister Florence Parly to Moscow. After years of radio silence, the two spoke with their Russian counterparts of a possible French-Russian security cooperation. Both the Chancellery and the Foreign Ministry in Berlin learned of the talks from the newspaper. Even in Paris, observers have begun bemoaning the lack of diplomatic build-up ahead of the president's numerous foreign policy activities.

There are many who argue that the French president's extremely active foreign policy is motivated by domestic considerations. Macron needs visible accomplishments ahead of municipal elections approaching in March. Otherwise, his party -- which is not deeply rooted in small towns or in the countryside -- could be facing a defeat. The protests that have been announced for the end of the year -- the Dec. 5 strike by the rail operator SNCF and the Paris Metro in addition to the expected resistance to the government's pension reform plan -- have the potential of placing even more pressure on Macron's shoulders.

Those Who Fight

Ultimately, though, Macron is likely just doing what he said he was committed to doing from the very beginning: Pursuing an active, self-confident approach to European policy with the aim of positioning the old Continent as a new geopolitical player.

That includes his trip to China two weeks ago, on which he demonstratively brought along German business leaders, German Education Minister Anja Karliczek and a European commissioner. Macron would like to see relations with China to be "Sino-European" from now on. And even if he did a bit of marketing for French products at the China International Import Expo in Shanghai, the Chinese very much saw their guest as an envoy of Europe. On the final day of his visit in Beijing, when the treaty between the EU and China to protect various European food products from counterfeiting was signed, both the Chinese flag and the EU flag were on display in the Great Hall of the People. That, too, was rather unusual for a bilateral visit.

For Macron, it is not a contradiction to put NATO through a kind of stress test in the name of his Europe policy. As the French president likely sees it, Europe cannot be strong and sovereign without a reliable and independent security policy.

The French state secretary for Europe, Amélie de Montchalin, has been involved in several discussions in recent days. It fell to her to soothe alarmed Eastern Europeans and to explain the comments her president had made. "The timing of the interview was not randomly chosen," she says. "The new European Commission will soon start work and the NATO summit in London is approaching in just over two weeks. We find ourselves at a moment when such questions must be asked."

It looks as though Emmanuel Macron -- at "a time of unprecedented crisis for our democracy," as he calls it -- simply doesn't want to wait any longer. He doesn't want to wait for Germany, nor does he want to wait for those who are primarily occupied with themselves at the moment, countries like Britain, Italy and Spain.

Being a good team player has never been among his top priorities.

Perhaps he has simply read a bit too much Victor Hugo: "Ceux qui vivent sont ceux qui luttent," he wrote. "Those who live are those who fight."

The Berlin Wall and the rise of nationalism

The 1989 promise of liberal democracy was a squandered opportunity

Philip Stephens

web_Global nationalism
© Ingram Pinn/Financial Times



Two great earthquakes shaped the present global order.

The first, in 1989, seemed to promise an irresistible march towards liberal democracy and open markets. The opportunity was squandered by those intoxicated with their apparent triumph.

A second set of seismic shocks then saw the world turn back towards nationalism and protectionism.

The end-of-history theory of the fall 30 years ago of the Berlin Wall was always, well, ahistorical.

There was nothing ineluctable about the advance of political pluralism and market economics.

The splintering of Yugoslavia into warring nationalisms should have been sufficient warning against hubris.

And yet.

The peaceful dissolution of the Soviet Union, the glad embrace by formerly communist states of parliamentary systems, and rising prosperity in China and other emerging economies gave reasonable cause for optimism that the world was set on a new course.

The UN awoke from cold war paralysis.

The US-led expulsion of Iraqi forces from Kuwait secured the backing of a global coalition.

European integration looked very much like an exportable prototype.

The UN doctrine of “responsibility to protect” underscored collective abhorrence of ethnic cleansing and genocide.

So if the destination may not have been assured, the direction of travel indisputably was on the side of democracy.

The Washington-based think-tank Freedom House’s annual survey of rights and liberties pinpoints 2007 as a high-water mark, with a retreat ever since.

China and Russia have grown bolder in their embrace of authoritarianism.

The Arab spring has turned to winter.

Nations such as Turkey, Hungary and Poland have been sliding steadily into illiberalism.

Rising populism and anti-immigrant sentiment in rich western democracies, Freedom House’s 2018 report notes, have offered succour to leaders who “give short shrift to fundamental civil and political liberties”.

Among them, it adds, is US President Donald Trump who voices “feelings of admiration and even personal friendship for some of the world’s most loathsome strongmen and dictators”.

You can find half a dozen plausible explanations as to what went wrong. Russia’s fall to economic anarchy threw open the doors to a leader promising to restore order and national pride.

China was never going to forget its “century of humiliation” and sign up for a global order led by the US.

As imagined by its friends, the Pax Americana would be that of a benign hegemon overseeing the international peace.

The events of September 11 2001 saw Washington repudiate rules in favour of unilateral military intervention.

In 1990, US President George HW Bush had laboured to gather broad backing for the war against Iraq’s Saddam Hussein.

His son George W Bush declared simply that others were “with us or against us”.

Democracy becomes tarnished when its promoters deliver it from the bay of a B-52 bomber.

For its part, the EU overlooked the role national identity had played in eastern Europe’s uprisings against rule from Moscow.

Nations that had only recently reclaimed their sovereignty were unlikely to share the postmodern enthusiasm of existing members for the pooling of national decision-making.

In the Middle East, the west’s focus on elections overlooked the need for the institutions and conventions that underpin liberal democracy.

The ballot box alone was never going to transform Libya.

One way or another, all of these things chipped away at the gloss of superiority bestowed on the west by its victory in the cold war.

None were of great consequence when measured against the event that shredded the claims and ambitions of the post-cold-war order.

The 2008 global financial crash, and the subsequent recession, delivered a powerful economic blow to the rich democracies even as it shattered the illusions invested in liberal democracy and globalisation.

There it was for all the world to see — the west had got it wrong, and wrong on a scale not seen since the Depression in the 1930s.

For all the gains that accrued from globalisation — and the rising fortunes of hundreds of millions in China, India and elsewhere attest to them — the devotion to unfettered markets enshrined in the so-called Washington consensus had been a catastrophic error.

Financial capitalism, it turned out, was inherently unstable; and once destabilised it collapsed like a house of cards.

Suddenly, the state-directed capitalism favoured by autocrats no longer seemed anachronistic.

The real damage, though, was done at home.

The rise of populists — Mr Trump in the US, the Brexiters in Britain, myriad nationalist parties elsewhere — exposed a fundamental divide.

The gains of globalisation had been reaped in the west by the few; the social contract that hitherto sustained public faith in politics and the market had been broken.

The elites had grown richer at the expense of the majority.

These populists offer scapegoats in place of remedies.

Nor should anyone harbour illusions about authoritarian alternatives.

The world is not flocking to imitate Moscow, Budapest and Ankara.

Even as they scorn democracy, tyrants and demagogues feel compelled to pay it lip service.

There is though one obvious lesson.

If they want to restore authority abroad, western leaders must first rebuild credibility at home.

Santiago Under Siege

How could the most prosperous city of what is, by all accounts, Latin America’s most prosperous and law-abiding country explode in protests marred by riots and looting? And what do recent events teach us about citizen dissatisfaction and the potential for violence in modern societies?

Andrés Velasco

velasco98_CLAUDIO REYESAFP via Getty Images_santiagoprotestmaskfire

SANTIAGO – At least 19 dead and untold wounded. A half-dozen subway stations attacked with firebombs. Hundreds of supermarkets vandalized and looted. The downtown headquarters of the country’s largest power distributor in flames. A city of nearly seven million people paralyzed. After a state of emergency is declared, army units patrol the streets and enforce a curfew.

How could Santiago, Chile – the most prosperous city in what is, by all accounts, Latin America’s most prosperous and law-abiding country – come to this? And what do recent events teach us about citizen dissatisfaction and the potential for violence in modern societies?

In fact, we cannot be certain. It all happened with dizzying speed. And a few days after the violence came the peaceful protests. Last Friday, 1.2 million people marched in downtown Santiago, in the largest street protest since those that helped remove General Augusto Pinochet from office 30 years ago.

The most common explanation is that a 3% increase in metro fares caused public indignation at rising prices and high inequality to boil over. That must be true: people with sufficient income who feel they are treated fairly do not loot and riot. But as an explanation on which to base policy changes, the standard account risks being simplistic.

Take price increases. Yes, Chile has a history of inflation. And, yes, because it is more prosperous, Santiago is more expensive than most Latin American cities. Yet Chilean inflation in the 12 months to September was barely 2.1%, and the central bank has been cutting interest rates because inflation is below its target.

Or take income inequality. Yes, for an upper-middle-income country, Chile is very unequal, with a Gini coefficient (most economists’ preferred measure of income disparity) at a high level of 46.6 in 2017 (100 represents absolute inequality). Yet according to the World Bank, the coefficient has fallen from an eye-popping 57.2 when Chile returned to democracy in 1990. The notion that rising income inequality is behind citizen discontent does not fit reality.

To understand the causes of a social phenomenon, one always must ask: Why here? Why now? Neither inflation nor rising income inequality provides a satisfactory answer.

Others claim that Chileans are simply fed up with the intrusion of markets and profit-seeking into every corner of daily life. Again, this hypothesis has an air of plausibility. Polls show widespread dissatisfaction with private companies that provide public services ranging from water and electricity to health insurance and pension-fund administration.

Yet those same surveys also show anger at the quality of state-provided services, whether in hospitals, clinics, or foster-care facilities. Over half of parents choose to send their children to privately-run voucher schools, even when it involves paying a fee, despite the availability of free state schools of comparable quality. And in 2017 a substantial plurality of Chileans voted for President Sebastián Piñera, a billionaire businessman and unabashed apologist for capitalism who ran on a platform of reigniting growth.

So, what is it, then? Why are millions of Chileans still marching in protest, ten days after the violence erupted?

For starters, Chile is not alone. In the last decade, places as diverse as Great Britain, Brazil, France, Hong Kong, and Ecuador have experienced similar episodes. Whatever the immediate local trigger, the scope, intensity, and often the violence of the ensuing protests seemed out of proportion with the initial cause. Rapid social change fuels tensions and contradictions in modern societies – even rich and successful ones – that seem to keep them barely a step or two from mayhem.

In Chile, an obvious suspect is monopoly abuses. While general price inflation in Chile is low, some prices that matter for family budgets are high and rising. Regulatory regimes designed to ensure investment in utilities, for example, have given companies excessive leeway to keep prices high. Likewise, Chile’s pharmacy chains have been found guilty of collusion and price gouging, as have toilet paper producers, chicken farmers, and long-haul bus companies.

Here is the paradox. Collusion and price fixing did not begin yesterday in Chile. But until a decade ago, sanctions were weak and the agency in charge had little authority and few resources to investigate. When the law changed, scandals began erupting every few months, raising public awareness of, and indignation with, monopolistic behavior. Today, price fixing is a criminal offense that carries jail sentences, and it seems plausible that such behavior is receding. But that very progress may have helped plant the seeds of public anger.

Turn next to the labor market. Chile’s unemployment rate hovers around 7% and wages have been rising well ahead of inflation. The bad news comes when you look at the structure of employment. Nearly one-third of the labor force is either self-employed or works in domestic service, in many cases without a formal contract and benefits.

Among those who have a formal job, most work on short-term contracts. Employment rates for women and young people are among the lowest in the OECD. Discrimination is rampant. Hundreds of thousands of women who head households do not have a job, while millions of workers who have a job today cannot be sure they will have any kind of income tomorrow.

The list of reforms that would remedy this situation – such as adaptable work schedules, modernized severance payment schemes, easier part-time work, better job training, and anti-discrimination laws with real teeth – is pretty self-evident. That is what worked in other countries in similar circumstances.

But here is the next paradox: as Chile has become more democratic, the same problems that plague advanced democracies have appeared. Politically influential insiders have blocked reforms, while labor-market outsiders are not represented. Few politicians speak for the unemployed young woman with two kids and no high-school diploma, who seldom votes anyway.

Puny pensions also contribute to people’s sense of fragility. Chile’s individual capitalization system earns kudos abroad, but the reality on the ground is more complex. Precisely because the labor market functions badly, Chileans retire with fewer than 20 years of savings, on average, in their accounts. And due to sharply rising longevity (itself a tremendous developmental success), they can expect to live 20 years or more after retirement.

Pensions could be adequate only if the rates of return on those savings were huge, but they are getting smaller by the day, in line with falling global real interest rates. Government-funded minimum pensions for people with no savings at all, plus a top-up for those with very low pensions, help alleviate the plight of 1.3 million people at the bottom of the income scale. But now the middle class is feeling the pinch – increasingly so as Chile’s baby-boom generation begins to retire under the private system.

And while income inequality has not been getting worse, other kinds of inequality may well have become more evident. Chile has joined the OECD club of rich countries, but in many ways it remains a traditional society riven with class privilege. Business leaders and cabinet members tend to come from a handful of private secondary schools in Santiago, especially when right-wing parties are in power, as they are today. The elite often seems to live in a world of its own. Last week, Cecilia Morel, the president’s wife, described the looting as “an alien invasion.”

None of this is new. But it may have become more painfully evident as the country develops. A generation ago, few working-class children attended university. Today, seven of ten students in higher education are the first in their families to attend college. Once they graduate, the frustration begins: to land the best jobs, academic performance matters less than having the “right” surname or connections.

Anger at elites is rampant in Chile, but scorn for the country’s political class is particularly deep. In 2018, 70% of Chileans believed that the country was governed for the benefit a handful of powerful groups. Barely 17% and 14% expressed trust in parliament and in political parties, respectively.

This is relatively new. High regard for civilian politicians during the transition to democracy nearly three decades ago gave way to a growing perception of insularity, and then a wave of campaign finance scandals. Today, the absence of term limits and parliamentarians’ outsize compensation (among the highest in Latin America) are huge magnets for public anger.

Lack of trust in politicians weakens people’s hopes for the future. And Chile’s recent economic deceleration, standing as it does in sharp contrast to Piñera’s ringing promises of economic growth, has exacerbated the problem. Perhaps it was these dashed hopes that brought the many tensions and contradictions in Chile to a boil.

There is now a unique opportunity to rewrite the social contract and deal decisively with the sources of citizen anger. But the risks are many. One is that voters will conclude that Chile’s gains were all more illusory than real, and will therefore throw the baby out with the bathwater. Another is that the current climate of fear and division will bring a populist to power, as has happened in Mexico, Brazil, and now Argentina.

In Chile, polls already show gains for populists of the extreme right and left. If that trend continues, the country’s turmoil could be far from over.

Andrés Velasco, a former presidential candidate and finance minister of Chile, is Dean of the School of Public Policy at the London School of Economics and Political Science. He is the author of numerous books and papers on international economics and development, and has served on the faculty at Harvard, Columbia, and New York Universities.

Are Investors Being ‘Aggressively Passive’ in Bond ETFs?

For bond allocations, think twice before reflexively allocating to index ETFs.

By David L. Braun, Avi Sharon


With investors looking to reduce risk in uncertain late-cycle markets, it’s not surprising that flows into bond exchange-traded funds (ETFs) have surged this year, outpacing flows to equity ETFs for the first time in a decade.

The lion’s share of the $97 billion in fixed income ETF flows through September have gone to passive, index-tracking ETFs (according to Bloomberg). But are investors missing out by defaulting to passive approaches?

Many investors may assume ETFs are passive by nature or by definition (they are not). Passive bond ETFs are not the only option – and for investors looking to potentially improve performance, actively managed fixed income ETFs may offer distinct advantages.

Bonds are different when it comes to active management

A key rationale many investors cite for preferring index-tracking equity approaches is that active management hasn’t paid off historically. But this has not held true for fixed income allocations.

Over the past 10 years, the median active equity manager has underperformed passive peers by approximately 86 basis points (bps) and lagged stated benchmarks by another 20 bps (see Figure 1).

The opposite has been true for fixed income: The median active bond manager has beaten its stated benchmark by an average of 81 bps per year and outperformed passive peers by 91 bps over the past decade (as of 30 June 2019).

Are Investors Being ‘Aggressively Passive’ in Bond ETFs?


Bond market inefficiencies provide alpha opportunities

Why is the story so different for bonds than for equities? We believe it boils down to inefficiencies across the fixed income markets, which can provide rich ground for active managers to seek beyond-benchmark returns – often with more attractive risk profiles.

Equities are traded in milliseconds on public exchanges, while bonds are largely still traded over the counter, slowly and in large blocks. And whereas equities are highly standardized, perpetual securities, bonds are far more heterogeneous in their terms and have finite maturities.

New issues of bonds (analogous to initial public offerings for stocks) are frequent, constituting about 20% of the U.S. corporate bond market each year, versus about 1% for U.S. equities.

This can give a potential advantage to asset managers with strong credit teams to analyze these new issues.

Moreover, when looking at the most prominent bond and equity indices – the Bloomberg Barclays U.S. Aggregate Bond Index and the S&P 500 – both give greater weight to entities with some of the least attractive characteristics: stocks with the highest market caps, and issuers with the most debt outstanding. That means that passive bond investors are essentially lending more to those with more debt.

Reconsider being ‘aggressively passive’ in bond ETFs

The ETF vehicle offers certain advantages, including efficient trading on an open exchange, continuous pricing throughout the day, and a simple way to gain diversified allocations. But passive ETFs generally suffer from below-index performance given the impact of trading costs and fees.

And given that overall return potential for bonds may be modest relative to equities, the potential return differential between a passive and active approach could have a significant impact. Especially in a low yield world, the excess return potential from active management may be particularly meaningful as a means to boost overall returns (and it would represent a larger share of that overall return). Of course, as with all investments, it is possible to lose money.

For investors wanting to make the most of their fixed income allocations as they seek to manage risk, we believe the compelling potential return advantage of actively managed ETFs should not be overlooked.

Obama, Trump and the Wars of Credibility

By: George Friedman



The United States is in the process of shifting a core dimension of its strategic doctrine. In the past, the U.S. resorted to the use of force to address international threats. Barack Obama was the first president to argue that the use of force, particularly in the Middle East, was costly and ineffectual and that other means had to be used to exercise foreign policy.

He ran his first campaign for president on this basis. He was only partially able to shift the direction of U.S. strategy. Donald Trump has extended Obama’s policy and applied it more consistently by refusing to strike at Iran over the Persian Gulf crisis and the Saudi oil facilities attack and, most recently, withdrawing from the Syria-Turkey border.

The shift in strategy was something I predicted in my 2011 book, “The Next Decade.” The basic argument was that the United States is now a global power with no global challenger, only regional ones of various sizes. Having a strategic doctrine of responding to challenges with military force would leave the decision on when to go to war up to the adversary.

John F. Kennedy once said, “Let every nation know, whether it wishes us well or ill, that we shall pay any price, bear any burden, meet any hardship, support any friend, oppose any foe, in order to assure the survival and the success of liberty.”

This doctrine made sense in dealing with the Soviet Union, but in a less orderly world, it reads like a blank check on U.S. military power and an invitation to other nations to draw the U.S. into combat at their will. I reasoned that a more nuanced foreign policy would emerge in the 2010s, one that would compel the U.S. to become more disciplined and selective in committing U.S. forces to combat.

In the 74 years since World War II ended, the U.S. has spent about 28 years, roughly 38 percent of the time, engaged in large-scale, division-level combat, leaving over 90,000 U.S. military personnel dead. This includes the Korean War, the Vietnam War, the Afghan War and the War in Iraq, and there have been other deployments in smaller conflicts.

Nearly three decades over a 74-year period is a staggering amount of time for any nation to be at war, particularly the leading global power.

With the exception of Operation Desert Storm, the United States has not won any of these wars. Korea ended in an armistice, with both sides at roughly the same point as when they began. Vietnam ended with the enemy flag flying over Saigon.

Afghanistan, Iraq and related wars did not end in outright defeat, but they have not ended in victory.

Given that the United States crushed both Japan and, with the help of the Allies, Germany in World War II and emerged with overwhelming military power, the increased tempo of U.S. military operations since 1945, combined with consistently unsatisfactory outcomes, must be analyzed to understand the emergence of the Obama-Trump doctrine.

One explanation that must be dispensed with is that the American public does not have the patience to allow a war to be fought to a satisfactory conclusion. There was no anti-war movement of any significance during Korea.

There was an anti-war movement over Vietnam, but the conflict continued for seven years, and the public voted overwhelmingly for pro-war Richard Nixon and against anti-war George McGovern in 1972. There has been opposition to the Iraq War, but it was only a peripheral reason for the U.S. drawdown there, after nine years of war.

World War II was fought on a different scale. It was a total war, one that could not be lost. Defeat would have posed fundamental dangers to the United States, so all necessary resources were devoted to the war effort. It was the central focus of society as a whole. Bringing massive resources to bear, including atomic bombs at its conclusion, the United States emerged from the war victorious.

None of the other conflicts were total wars that involved existential threats to the United States.

During the Cold War, the interventions in Korea and Vietnam were the result of indirect U.S. interests. From the Truman administration’s perspective, Korea was outside core U.S. interests. The U.S. had no treaty with or strategic interest in South Vietnam. In both cases, the benefits of engaging in conflict were indirect.

The U.S. strategy in the Cold War was containment. The U.S. did not intend to invade the Soviet Union, or later China, but it opposed its expansion. The U.S. got involved in both Korea and Vietnam to defend the credibility of the doctrine of containment, fearing that a lack of U.S. engagement in these conflicts would be interpreted by the Soviets and Chinese as a lack of commitment to the doctrine.

Even more important, the U.S. was afraid that staying out of these wars would lead its allies to draw the conclusion that American guarantees were hollow and that the alliance structure needed for the containment strategy would collapse.

The U.S. engaged in the two wars, therefore, not out of strategic necessity but to demonstrate American reliability. They therefore could not be fought as total wars. The amount of effort required to show a willingness to engage was much less than the amount of effort needed to decisively crush enemy forces.

It was necessary to demonstrate U.S. will for global reasons, but imprudent to devote the force needed to win the war. It was also impossible to withdraw from the war, as abandoning a conflict would be the same as refusing to engage. The wars were being fought for the sake of demonstrating that the U.S. was willing to fight wars, and no coherent strategy or even clear definition of what victory meant or how to achieve it emerged. In a strange way, this made sense.

Maintaining the confidence of West Germany, Turkey, Japan and all other U.S. allies was of enormous strategic importance, and Korea and South Vietnam were needed to hold the alliance together. Over 90,000 died in wars that were gestures, yet how many more would have died if the gestures were not made? That was the logic, but the truth is that no one anticipated the length of engagement and amount of bloodshed in either war. Wars fought to reassure allies have no strategic basis on which to calculate such things.

What we will call the anti-jihadist wars were framed differently but had similar results. After 9/11, the U.S. goal was to destroy Islamic jihadists and governments that gave them haven and to impose governments favorably inclined to the United States. The problem was that terrorists are mobile. Al-Qaida was a global, sparse and capable force. It could exist anywhere, including hostile territory, and its members were capable and difficult to locate, making them excellent covert operators, as seen on 9/11.

To dismantle the organization, it was assumed that the U.S. had to deny al-Qaida sanctuary for its operations and have the cooperation of countries in the region, ensuring that they would resist al-Qaida and provide intelligence. The invasion of Afghanistan was designed to displace the Taliban and force al-Qaida to disperse.

The Taliban withdrew, dispersed and reformed. Al-Qaida was built to be mobile. This placed a premium on getting others to support the American effort, a difficult task inasmuch as the U.S. withdrawal from Lebanon and Somalia made them feel the U.S. wouldn’t back them up. In Iraq, there were many strands behind the U.S. invasion, but credibility was an important one. In the end, the problem was that al-Qaida was not destroyed when it had to mobilize. In addition, occupying a country that is hostile to foreign interference is impossible. Even the Nazis couldn’t defeat the Russian and Yugoslav partisans, and they were far less gentle than the U.S. was.

Demonstrating credibility was part of what motivated the jihadist wars, just as it motivated U.S. involvement in the wars in Korea and Vietnam. The problem with wars designed to demonstrate U.S. will, however, is that they are almost by definition without end. But if the U.S. is going to lead a coalition, credibility is a critical asset, even if the likelihood of success in the war is uncertain. There is therefore an inherent dilemma.

In World War II, the war was aligned with U.S. strategy. In the wars that have been fought since then, the conflicts have not been aligned with U.S. strategy. As a result, stalemate or defeat did not undermine basic U.S. interests. The conflicts created vacuums in regions where the U.S. had interests, but all forces were committed to what I will christen as wars of credibility. These were wars that didn’t have to be won, but only fought.

Given the sweeping breadth of U.S. power, and the lack of challengers that might absorb the U.S. as it was absorbed in World War II (including China and Russia), coalition building and management becomes an end in itself. And that leaves the U.S. constantly off balance, as in the long run it undermines coalitions anyway.

It was inevitable, therefore, that the U.S. would significantly curtail its military involvement and devote resources to upgrading the force, rather than constant deployment.

The next business revolution

American business schools are reinventing the MBA

About time 




ON A VISIT to New York in October Marc Benioff, boss of Salesforce, compared Facebook to cigarettes and backed a corporate tax hike to deal with homelessness in San Francisco. If badmouthing a fellow technology giant and cheering the taxman were not heterodox enough for a billionaire entrepreneur, Mr Benioff laid into American management education. It “programmes” students to favour profit over the public good. This, he noted, is out of step with “the new capitalism”.

Many deans concur. “We need our students to be thoughtful about the role of business in society, particularly at a moment in time when capitalism is coming under attack,” says William Boulding of Duke’s Fuqua School of Business. Nitin Nohria of Harvard Business School (HBS) reports how younger alumni and incoming classes want “the place of work to reflect purpose and values”. Jonathan Levin of Stanford’s Graduate School of Business (GSB) talks of business schools’ responsibility to recognise the societal consequences of corporate actions. “Corporations, their leaders and owners need to act to restore trust,” he intones.

America’s business schools still dominate our annual ranking of the world’s top MBAs (see table). But the industry is being shaken up. According to the Graduate Management Admission Council (GMAC), an industry association, American MBA programmes received 7% fewer applicants this year than last. Nearly three-quarters of full-time, two-year MBA programmes reported declines from coast to coast. Not even the most illustrious ones were spared: HBS (located in Boston) and Stanford’s GSB (in Palo Alto) both saw applications dip by 6% or so.

Schools face growing competition from overseas and online programmes—and, as Mr Benioff’s critique implies, questions over hidebound curriculums. “We’re being disrupted left, right and centre,” confesses Susan Fournier, dean of Boston University’s Questrom School of Business.



When management education boomed in the 1960s, American schools taught mostly American students. As the world economy globalised in the 1980s and 1990s, so too did American curriculums and student bodies. Sangeet Chowfla, who heads GMAC, now discerns a “third wave”: improved schools outside America are letting foreign students study closer to home (and future employers).

Many offer cheaper one-year MBAs, popular in Europe but uncommon across the pond.

Whereas three in four two-year MBA programmes in America saw declines in overseas applicants in the latest application cycle, numbers applying to Asian business schools rose by 9% from 2017 to 2018. A recent uptick in America’s anti-immigrant sentiment is accelerating the trend.

Americans, too, are cooling on MBAs. More than half of American schools report fewer domestic applicants. Soaring tuition costs, which have far outpaced inflation, put them off as much as they do foreigners. A top-notch MBA will set you back more than $200,000 (including living costs). Even with financial aid, many students are saddled with $100,000 debts at graduation.

The opportunity cost of forgoing two years’ worth of paycheques is higher when the economy is booming and labour markets are tight. Weak demand has caused the number of full-time MBA programmes in America to fall by nearly a tenth between 2014 and 2018, according to the Association to Advance Collegiate Schools of Business, another industry body.

Geoffrey Garrett, dean of the Wharton School, at the University of Pennsylvania, believes that a flight to quality is benefiting top institutions like his—and their graduates. Add non-wage compensation and alumni often recoup their investments in a few years. Not counting signing bonuses, the average base salary for graduates of the five American schools with the highest earning potential was $139,000.

Consultancies and investment banks, historically the keenest MBA recruiters, claim their appetite for holders of elite degrees has not diminished. A prestigious MBA “puts a floor on your career”, explains Kostya Simonenko, a 28-year-old consultant on leave from Oliver Wyman (which is paying for his course at Columbia Business School). Silicon Valley, which used to dismiss MBAs as overpaid know-nothings, has become less hostile.

As startups grow into large corporations, they need managers to help run things, not just software engineers to run code. A survey of recruiters by GMAC this year found that 80% of technology companies planned to hire MBAs, on a par with consultancies (82%) and financial firms (77%).

Even the finest schools, though, are not sheltered from the forces buffeting business education. Global competition and new technology platforms enable a lower cost structure for the delivery of high-quality courses. This forces “a reckoning of the MBA value proposition”, says Ms Fournier.

As part of that reckoning, Questrom has teamed up with edX, a big online-education firm, to offer a full MBA degree online for just $24,000, less than a third of the cost of its on-campus equivalent. Better to cannibalise yourself than let others do it, as Ms Fournier puts it. MIT’s Sloan School of Management provides similarly affordable bundles of online courses, dubbed MicroMasters, in areas like supply-chain management and finance.

These grant certificates but the credits will be honoured if a student one day decides to pursue a full degree. 2U, an online-education platform, is introducing deferred-tuition schemes for some hybrid MBA degrees. It will share the upfront costs with its business-school partners; students will pay only when they get a job.

It is not just how MBA courses are taught that is changing. So, too, is what they teach. Many budding woke capitalists agree with Mr Benioff—and demand to be taught business beyond the primacy of shareholder value. At Stanford Luisa Gerstner, a millennial MBA student from Germany, notes that sustainable capitalism plays a more central role in European schools. Julia Osterman, her American classmate, laments how, despite some social, environmental and ethical topics in its curriculum, core classes are still “too Finance 101”.

Some of their professors are not so sure. One greybeard at HBS estimates that a third of its faculty (and many older alumni) view the embrace of cuddly “stakeholder capitalism” as an unrigorous sop to political correctness. It certainly introduces lots of grey areas, Mr Boulding concedes. But, he says, schools can at least provide students with “frameworks for making choices”.

A new course at Duke is entitled “Capitalism and Common Purpose in a World of Differences”.

HBS has made “Leadership and Corporate Accountability” (which delves into “the responsibilities of business to the broader system in which it is embedded”) a required first-year course, with case studies weighing up things like the morality of looking beyond financial metrics at Japan’s Government Pension Investment Fund.

Recoding academies

Curriculums are being transformed in less lofty ways, too. Employers, who partly or wholly bankroll half of all executive education, which earns elite schools between $100m and $150m a year, want it to impart technical skills. In response, deans such as Costis Maglaras, the newish head of Columbia Business School (and an engineer by training), are bolting courses on data, analytics and programming onto the timetable.

As their popularity rises, they may displace stodgier subjects. Columbia used to offer several courses on debt markets but now offers perhaps one each academic year. Meanwhile, students have flocked to coding classes. The idea is not to turn business types into boffins but to prepare them to work with and manage technical staff, says Mr Maglaras. A recruiter for a big consultancy affirms that tech-savvy MBAs are “very attractive”.

Richard Lyons, former dean of the Haas Business School at the University of California, Berkeley, sees the future in providing lifelong professional education as a service: “Give alumni know-how on demand, searchable online.” Scott DeRue, dean of the University of Michigan’s Ross School of Business, is giving alumni tuition-free access to executive education.

“The new stuff will come from insurgents, not the big MBA schools,” thinks John Kao, a management guru who formerly taught at HBS. He wants training benchmarks and standardised transcripts to make skills portable and universally recognised.

At HBS, home to perhaps the most hallowed MBA, Mr Nohria accepts that the market for its traditional offering is shrinking. In a sign of the times, his school has frozen tuition fees. He sees a dramatic expansion for “unbundlers” of online education, who “separate knowing, doing and being”.

In time, he says, they will converge with “bundlers” like HBS. Far from collapsing, he reckons, management education will the richer for it.

The Politics of Frustration in Latin America

The rapidly escalating protests across the region reflect people's dashed economic expectations, and thus differ from the demonstrations in Beirut and Hong Kong against undemocratic regimes. The risk, of course, is that Latin American governments resort to Chinese-style tactics and turn economic malaise into a struggle over the future of democracy.

Jeremy Adelman , Pablo Pryluka

adelman3_MARTIN BERNETTIAFP via Getty Images_chileprotestburningbus


PRINCETON – All over Latin America, public patience is wearing thin, with violence in Chile and the return to power of Peronists in Argentina. For almost 40 years, leaders and voters have struggled to realign economies with global markets, leavening the adjustment with social policies to protect the worst-off. Center-right and center-left coalitions agreed on broad strokes. While they argued over taxes and other issues, Latin Americans accepted the need for foreign markets and foreign investment.

For the past ten years, however, world trade has slowed. The World Trade Organization predicts anemic growth of 3% at best. Trade wars, stalled treaties, and the return of economic nationalism pose a real threat to Latin Americans and others who depend on foreign markets.

To make matters worse, income inequality has widened. Already the world’s most unfair region in this regard, Latin America had made some progress before 2015. But slower GDP growth and stumbling social policies have reversed the trend since then.

Latin American leaders across the political spectrum find themselves in a bind. As the world turned its back on globalization and open borders in favor of national and regional blocs, pro-globalization governments faced the yearnings of voters who took seriously the promise of economic rights and social wellbeing.

At the same time, appeals to tradition, family, and property have proved to be seductive for a growing part of the population, fueling support for Brazil’s Jair Bolsonaro, Peru’s Keiko Fujimori, or even Chile’s José Antonio Kast.

People are impatient and indignant.

Argentina has been in an economic tailspin since 2017. Real wages have fallen. Poverty is up. Two years earlier, in 2015, Mauricio Macri won the presidency on his promise that fiscal adjustment and opening Argentina to the world would spur economic revival. Instead, they paved the way for his defeat. In a few short years, the package of pro-market reforms and economic opening seemed out of step with the rest of the world. Deglobalization, nativism, and protectionism set a new tone for politics, with frustration and uncertainty about the future overshadowing hope.

Frustration is even afflicting the region’s paragon of open-market politics, Chile. On October 18, a wave of protests led President Sebastián Piñera’s government to rely on gendarmes, rubber bullets, and tear gas to repress rioting and looting. During the ensuing week, the world watched images that seemed to contradict the stability of the “Chilean model.”

The riots and the bloody response of the army and the carabineros were followed by videos of Piñera, surrounded by men in fatigues, declaring that the country was “at war,” rhetoric that triggered memories of Augusto Pinochet’s 17-year military dictatorship. Despite Chile’s impressive economic growth and poverty reduction since the dictatorship’s end in 1990, inequality loomed large, and those who have yet to see the benefits have run out of patience.

Even progressive governments seem to have run out of time. A few weeks earlier, when Ecuador’s government announced a reduction in fuel subsidies, a wave of popular unrest forced the government of President Lenin Moreno to flee the capital, Quito. Heir to the center-left government of Rafael Correa, Moreno had turned to the International Monetary Fund and subscribed to a program of fiscal cuts. As in Chile, massive street demonstrations were met by severe repression. In the end, Moreno had to mothball the controversial policies to restore peace.

In some cases, malaise has led to paralysis. In Peru, the resignation of President Pedro Pablo Kuczynski in March 2018 only emboldened the populist forces of fujimorismo in Congress and prompted demonstrations denouncing the illegitimacy of Peruvian politicians. The shutdown of the Congress last month by the current president, Martín Vizcarra, casts doubt on the country’s future.

Then there are the shockwaves from Bolsonaro’s victory in Brazil’s presidential election last year, which brought an end to the country’s long-standing center-left consensus and ushered in a new regime of cronyism and incivility. With the IMF predicting economic growth this year of 0.8%, it’s hard to say how long Bolsonaro’s incendiary rhetoric will keep his supporters happy. Time might be running out for him, too.

Each country is going through its own drama. But what is clear across the region is that as the fabric of global integration comes undone, Latin American governments face spiking popular dissatisfaction and a sharp downturn in public confidence in governments and institutions. The result is an escalation of protest and repressive responses, turning modest demonstrations into massive conflicts.

So far, the outlier is Argentina, where the social unrest is being channeled through elections. It is worth recalling, however, that many who voted for the Peronists once voted for Macri’s free-market reforms. How long they will wait for Alberto Fernández’s promises to bear fruit is unclear. While the new president is a wily pragmatist, even he knows that voters’ loyalties, especially when pressed to the limit of subsistence, are unstable.

Something fundamental has changed. Latin America cannot hitch its fortunes to the fading promises of globalization. Nor cannot it return to old-style populism. The only certainty is that the public’s fuse is short; many years of promises have dashed expectations at a time when the future looks especially bleak.

This is not the same kind of unrest seen in Beirut or Hong Kong, where people are taking to the streets to fight undemocratic regimes. This is about economic frustration, amplified by the seeming absence of alternatives to failed globalization.

The risk, of course, is that governments resort to Chinese-style tactics and turn economic malaise into a struggle over the future of democracy. Piñera’s ominous talk of an internal war, while surrounded by uniformed military officers, does not bode well.


Jeremy Adelman is Professor of History at Princeton University.

Pablo Pryluka is a doctoral candidate in history at Princeton University.


Saudi Aramco’s IPO

Aramco is both the oil sector’s Goliath and a firm vexed by problems

Is it worth a prince’s ransom?




IN THE HEADQUARTERS of the world’s most profitable company, past its heavily guarded perimeter, down a road, through another security gate, out of the blazing sun and into a cool office building sit box after box of rocks. They are samples of anhydrite, shale, dolomite and grainstone, retrieved from kilometres below ground.

A block of grainstone looks perfectly ordinary, its dark surface dotted with pores. But nestled in this rock were the remains of the tiny marine animals and plants which blanketed the Arabian peninsula before there was such a thing, over 100m years ago, and which still give the rock a faint, familiar scent: oil. “Smells like money,” says one executive—$111bn, to be precise.

That was the net income earned last year by Saudi Aramco, the kingdom’s state-owned oil company. It is nearly twice that of Apple, the world’s most profitable listed firm, and more than the combined earnings of the five biggest international oil companies—ExxonMobil, Royal Dutch Shell, BP, Chevron and Total. For decades, the riches from Saudi Arabia’s vast reserves have been the exclusive property of Saudi Arabia. Muhammad bin Salman, the kingdom’s crown prince, wants that to change.

In 2016 Prince Muhammad told this newspaper he was keen to list a portion of Aramco’s shares, in an effort to raise money to diversify the kingdom’s economy. After much delay, those plans seem to be proceeding. In September the government appointed Yasir al-Rumayyan, the head of the kingdom’s sovereign-wealth fund, to be the new chairman of Aramco and charged him with taking the listing forward.

Eleven banks and financial advisers have been working feverishly to that end. If all goes according to schedule, in early November the kingdom will announce its intention to list 2-3% of Aramco’s shares on the Tadawul, the Saudi stock exchange. It would probably be the biggest initial public offering (IPO) in history, raising $30bn or more and eclipsing Alibaba’s $25bn listing in 2014. A second listing may follow on a foreign exchange sometime in 2020.

Yet almost four years after Prince Muhammad announced the desire for an IPO, there remains a chance it is postponed. Disagreement over the company’s value has already delayed the listing—Aramco was expected to announce its intention to float in late October. It is unclear what price will satisfy the crown prince, who said in 2016 he hoped for a valuation of $2trn. Independent analysts think he would be lucky to get $1.5trn.

The uncertainty points to a contradiction at the heart of Aramco, at once the oil industry’s undisputed titan and a company plagued by problems. In September drones struck two Aramco facilities in eastern Saudi Arabia, knocking out more than half of its production.

Further attacks are possible—America says Iran was responsible. In October Fitch downgraded Aramco’s credit rating, owing to risks posed by geopolitics and its economically shaky sovereign. Saudi Arabia’s ability to use its heft to support global oil prices is in doubt. The oil price has sunk to about $60 a barrel, from $75 in April, amid fears of a recession.

What is more, investors have soured on the oil industry. Energy’s weighting in the S&P 500 index dipped below 5% in June, less than a third of its level in 2008. Oil markets are notoriously volatile; they may become more so as efforts to mitigate climate change hit oil consumption. “If this IPO was 15 years ago, it would be a compelling investment opportunity,” says Oswald Clint of Bernstein, a financial firm. “But the outlook for oil demand and the energy sector is opaque.”

Aramco maintains that, regardless of the oil market’s broader troubles, it will outcompete its rivals. Recently the company has used deals and new business units to secure customers, diversify its revenue and maximise the value of its oil. Its boosters like to say that the world’s last barrel of oil will come from Saudi Arabia.

But it is unclear what value investors will ascribe to such a distant possibility. As international energy giants and petrostates jostle to find their footing in an uncertain era, no company will loom larger than Aramco.

The company’s history is in some ways similar to that of other national oil giants. Americans drilled their first successful well in Saudi Arabia in 1938; the Arabian American Oil Company once had its headquarters in New York. The nationalisation of Aramco from 1973 to 1981 was part of a wave of requisitions that swept oilfields from Venezuela to Malaysia.

However Aramco is no ordinary national oil company. It is widely regarded by those within the industry as being well run, with professional managers and a distinct culture. The Aramco compound in Dhahran, in Saudi Arabia’s Eastern Province, is a world unto itself, home to 15,000 people. It has schools, gyms, food shops and streets lined with quaint houses—the campus resembles an Arizona suburb, with more mosques. About 90% of Aramco’s employees are Saudi, but women are as likely to wear trousers as an abaya.

Nor is Saudi Arabia an ordinary petrostate. Much of its treasure resides in the Eastern Province, including oilfields such as the celebrated 48.3bn-barrel Ghawar, shaped like a dancer’s leg en pointe. Oil is also tucked beneath the rolling dunes of the Empty Quarter and the seabed of the Gulf. In all Aramco has nearly 500 reservoirs, with 260bn barrels of proved reserves. That is more than triple the combined proved reserves of the five supermajors. Last year Aramco pumped one in eight of the world’s barrels of crude.

Such astonishing scale has ensured that Saudi Arabia remains the de facto leader of the Organisation of the Petroleum Exporting Countries (OPEC). American frackers may collectively produce more oil, but they operate independently. Saudi Arabia alone can ramp production up and down quickly in the attempt to tame volatile oil markets.

Oil has brought the kingdom prosperity. Saudi Arabia sustains its absolute monarchy by offering citizens a safety-net, including free education and health care, as well as a guaranteed-income programme. The kingdom’s natural resources benefit some Saudis more than others. In posh parts of Riyadh and Dammam, lush greenery peeks above the concrete walls separating residential compounds from the dusty streets beyond. As a whole, however, Saudi Arabia is dangerously dependent on crude.

Oil accounts for nearly 70% of the government’s revenue and almost 80% of exports. Non-oil activity is often the result of government spending, which is itself dependent on oil. It is hard to find a person or service in the kingdom that does not somehow rely on oil or gas. The arid climate requires the use of energy-intensive desalination plants—in Saudi Arabia, even water depends on fossil fuel.

Swing consumer

The country has long been vulnerable to shifts in the oil price. However the kingdom faces three new, big problems. First, shale has transformed America into the world’s largest oil producer, vexing OPEC’s efforts to maintain high, stable prices. Second, Saudi Arabia has a burgeoning, youthful population. The oil industry, which requires capital but not much labour, cannot employ enough of them. The IMF reckons that up to 1m jobs could be needed in Saudi Arabia in the next five years.




Petropolis


The third risk is the largest and most uncertain: global oil demand may subside. Economic growth and demand, which have risen in sync, could be decoupled as the threat of climate change grows. However no one knows whether this might happen, or when. America’s Energy Information Administration, within President Donald Trump’s energy department, expects the world to remain thirsty for oil, with demand rising up until 2050.

ExxonMobil also takes a bullish view. Mohammed al-Qahtani, Aramco’s head of upstream, expects that “demand will be robust for the next two decades plus”—the company models its reservoirs to 2200. Some oil companies tactfully present a variety of scenarios, as does the International Energy Agency (IEA), a forecaster. Any tidy prediction belies a tangle of assumptions and debate, according to an independent expert who has reviewed the IEA’s drafts.

Little wonder, then, that Prince Muhammad wants to diversify. His Vision 2030 aspires to transform the economy through strategic investment—for instance in manufacturing and “special economic zones”, such as a planned robotic city called NEOM near the Red Sea. Raising cash for that depends on the Aramco IPO.

There have been many reasons to delay, including concern over legal exposure that might come from listing in New York, the desire to acquire Sabic, the kingdom’s giant petrochemical company, as well as the valuation question. This time last year, plans for an offering seemed postponed indefinitely amid uproar over the murder of Jamal Khashoggi, a dissident journalist, at the Saudi consulate in Istanbul.

Since then, however, Aramco has announced a $69bn deal to buy Sabic. To raise money for the transaction, in April Aramco issued $12bn in bonds, which investors lapped up. The publication of a 469-page bond prospectus eased anxiety about letting the world pore over Aramco’s books. Meanwhile, the rationale for pursuing a listing—to raise money to diversify the economy—remains as urgent as ever.

Preparations for an IPO accelerated after the bond offering. Aramco held its first earnings call with investors in August (analysts, perhaps eager to establish good will, have rarely been so polite). To co-ordinate the listing the government has hired six global banks, JPMorgan, Goldman Sachs, Credit Suisse, Citi, HSBC, and Bank of America Merrill Lynch, as well as Saudi Arabia’s Samba and National Commercial Bank. Michael Klein, Moelis and Lazard are serving as advisers, say insiders. Investors, at last, are on the threshold of owning a sliver of Aramco’s shares.

The trouble with letting the market loose on Aramco, however, is that it tends to make up its own mind about valuations. This seems to make the crown prince uneasy. Bloomberg has reported that the government is exploring ways to limit volatility in trading after the Tadawul listing. The government expects local business leaders to buy shares enthusiastically to support Aramco’s valuation. “It is seen as part of being loyal,” says one seasoned businessman in Riyadh. “It’s not an explicit quid pro quo,” says another. “However you cannot do business in Saudi without being seen favourably by the power corridors.” Saudi banks have asked local investors if they would increase their stakes if offered new lines of credit.

If an IPO does proceed, however, Aramco’s valuation will eventually reflect the business itself: a company of staggering scale, aggressive strategy and unique complications. In recent years Aramco has moved to strengthen its traditional business and expand to new areas—Mr Qahtani describes this as “opportunistic”, not defensive. Changes include establishing a trading operation and investing more in natural-gas projects.

Its most important strategic shift is to move downstream, into petrochemicals. Its purchase of a 70% stake in Sabic, announced in March, serves the twin goals of raising cash for Saudi Arabia’s sovereign- wealth fund and diversifying Aramco’s revenue. The IEA expects petrochemicals to account for almost half of the growth in oil demand up to 2050. Sabic is already the world’s fourth-largest chemical company, generating $14bn of gross operating profit last year. Its businesses span fertilisers in India to plastics used in Range Rovers.

Aramco has also used its deep pockets to bolster its standing in Asia. In August Reliance, an Indian conglomerate, said that Aramco had taken a 20% stake in its refining unit, for roughly $15bn. Aramco has announced other investments in Asia, including projects in South Korea, Malaysia and China.

Joint ventures in refineries and petrochemical plants help Aramco hedge against low oil prices.

They also include agreements to be the projects’ long-term supplier of crude. Deal by deal, Aramco is securing customers for its oil in Asia, where demand is most likely to rise. Asia buys 71% of the company’s crude exports.

Some national oil companies are trying to pursue a similar strategy. ADNOC, of the United Arab Emirates, is joining up with Aramco on a big refining complex in India. What makes Aramco most distinct, however, is how cheaply it can pump oil. Its centralised resources, slick infrastructure and decades spent honing its drilling mean that extracting oil costs just $2.80 a barrel, one-third the average level of international oil companies. That helps Aramco achieve margins more than twice that of Rosneft, a Russian giant, and nearly four times that of Shell (see chart 1).




Cheaper and cleaner

The Economist worked with Rystad Energy, a research firm, to examine how the value of Saudi Arabia’s reserves might stack up if demand wanes—because of, say, the strengthening of American climate regulations after an election. The oil price at which a company could make a 10% return, the breakeven price, is one way of showing which countries’ reserves are most vulnerable.

Another way is to look at how much energy is used to extract oil, thereby increasing emissions, which would add a further layer of costs if carbon were to be taxed. On both measures, Saudi Arabia stands out.





Aramco’s breakeven costs for new projects, even after tax, are $31, according to Rystad Energy’s data, slightly higher than Iran, Iraq or Kuwait but less than half the level of Russia and two-thirds the level in America. Its carbon-dioxide emissions from extraction and flaring are less than half the global average.

A separate analysis, published last year by researchers at Stanford University and Aramco, found similar results (see chart 2). Indeed, Aramco exposes its peers’ weakness. Canada and Venezuela are particularly vulnerable, owing to production that is both dear and dirty. Compared with those of many rivals, Aramco’s reserves therefore seem well situated, no matter what happens to demand.

Yet even with its relative bounty it faces several big risks. The trove of oil assets under Saudi soil remain vulnerable to attack. Aramco executives, who usually refer to the September strikes as “the incident”, point out that repairs were done quickly.

However it was no one-off. The attacks in September followed strikes on a large pipeline, airports and an oilfield. Further incidents could complicate Aramco’s efforts to secure more long-term customers.

The kingdom’s claim on Aramco also makes investors nervous. Saudi Arabia has tried to ease their concern. Reforms announced in 2017 included reducing Aramco’s tax rate from 85% to 50%. In September Aramco unveiled a new dividend policy, which envisions a total payout of $75bn in 2020 and beyond.

Non-state shareholders will receive a proportionate share of this, and their absolute payout will be protected, even if the total value of Aramco’s dividend drops. Further, it said that dividend would probably rise.

However Aramco’s dividend yield, at a valuation of $1.5trn, remains lower than those of the European supermajors. Some investors remain squeamish about what might happen if oil prices were depressed for a long period. Aramco could still be profitable, but its profits might not be high enough to sustain the kingdom’s budget.

Prince Muhammad’s Vision 2030 might not go as planned—one of the Saudi sovereign-wealth fund’s big early investments was in SoftBank’s Vision Fund, which made a disastrous bet on WeWork. “If oil prices are lower, you could expect that the state would potentially increase taxes,” says Dmitry Marinchenko of Fitch. The promise to maintain high dividends to non-state shareholders, he points out, would not be legally sacrosanct.

There remains the question of what a listed Aramco would mean for OPEC, and therefore for oil markets. Historically Saudi Arabia has curbed its own output, often beyond the levels required by OPEC, in the effort to support oil prices. Khalid al-Falih long served as both oil minister and Aramco’s chairman.

In September the government sacked him from both posts, ensuring that one person now oversees Aramco and another the oil ministry. Yet the rational goals of a listed Aramco—boosting production to lower prices and squeeze rivals, for instance—may diverge wildly from the historic goals of OPEC.

Such uncertainties will weigh on Aramco, before and after any listing. Rivals are watching with interest. Saudi Arabia’s transition to oil’s new era is tortured. For the many countries with higher costs and less cash, it may be even more so.

China's Secret Weapon That Could Swing the Trade War 
by Nick Giambruno




"We’re going to war in the South China Sea… There’s no doubt about that."

Steve Bannon – previously one of President Trump’s closest political advisers – said these words shortly after Trump became president. He was referring to military conflict between China and the US… one that would likely be the biggest war since WWII.

While these words might seem like hyperbole to many, they touch on something important… arguably the biggest story for the next generation.

Watching the mainstream media circus covering Trump and China gives the impression that once the two sides reach a trade agreement, it will be back to business as usual. But that view completely misses the Big Picture…

The trade war between the US and China was always just a sideshow of a much bigger issue: Who will be the world’s dominant power?

It will be China, or it will be the US.

It can’t be both.

Could the US ever accept being No. 2? We won’t have to wait long to find out.

That’s because China is on the path to having double the US’ GDP by 2030.

The situation will soon reach a tipping point.

The US finds itself in the same position that previous established powers did as they were challenged by rising powers. Many of these countries found it preferable to strike while the rising power was still relatively weak, as they had a greater chance of prevailing than if they waited.

This dynamic is called "Thucydides’ Trap." It’s named after the Athenian historian Thucydides, who observed this dynamic in Ancient Greece.

Graham Allison, a professor at Harvard, has studied 16 cases of Thucydides’ Trap throughout history. In 12 of them – 75% of the time – the result was war.

War between the US and China is not inevitable. But if history is any guide, there’s an excellent chance – say, 75% – that Steve Bannon will be proven correct soon.

One thing I’m sure of is that the mainstream financial media are wrong about the trade war.

Even if some sort of deal is worked out, it will do nothing to resolve the larger problem of Thucydides’ Trap.

China’s rise is a Big Idea… arguably the Biggest Idea of our time.

Lee Kuan Yew, the former leader of Singapore, put it like this:

The size of China’s displacement of the world balance is such that the world must find a new balance.

It is not possible to pretend that this is just another big player. This is the biggest player in the history of the world.

Rising tension between the US and China is a trend you can bet on, regardless of what happens in the trade war. I think it’s a near-certainty. And it presents an opportunity for savvy investors.

You see, China has an ace up its sleeve… and as tensions between the US and China escalate, it will be forced to play this card. That will send this one industry soaring, potentially 10-to-1 overnight.

And it all has to do with a special group of metals no one’s talking about…


Rare Earth Elements

A consequence of the China-US rivalry is the near-certainty rare earth elements (REEs) will come into play.

REEs are 17 elements mostly clumped together at the end of the periodic table with atomic numbers 21, 39, and 57 to 71.

For example, erbium amplifies light and is used in fiber optic cables.

Gadolinium is used in X-rays and MRI machines.

Neodymium is used in cell phones and laptops.

Europium is used in lasers and fluorescent lights.



Most people have never heard of these obscure elements, but they are absolutely essential to modern life.

They’re used to make crucial components for advanced electronics like iPhones, electric cars, flat-screen TVs, computers, and sophisticated military equipment – like guidance systems, drones, anti-missile systems, radars, and fighter jets.

The screen you are reading this on relies on REEs.

There is no substitute for REEs in advanced electronics. The US military and US consumers are wholly dependent on them.

And China has a virtual monopoly in the space. It produces around 90% of global REE supplies. It also produces nearly all of the world’s more valuable heavy rare earths.




Separating REEs from ore is toxic, expensive, and dangerous to the workers. China has fewer environmental regulations and therefore disregards environmental and labor safety concerns in a way that other countries cannot. This lets it produce REEs at a much lower cost than its competitors.

Further, Beijing subsidizes the industry. It’s unknown exactly how much China subsidizes its REE industry (as it’s notoriously opaque), but it’s clear the Chinese government considers the industry a national priority… and will pour as much money into it as needed.

In short, lack of environmental and employee regulations… along with a big subsidy… are how China achieved dominance in the REE business. As Chinese leader Deng Xiaoping once said, "The Middle East has oil. China has rare earths.

"That’s why, as we can see in the graphic below, there is only one operable dedicated REE mine in the entire world outside of China. Other non-Chinese mines are years away from production. In other words, there is no alternative to China in the short term.




How to Profit From "Thucydides' Trap"

Even a whiff of the possibility that China could restrict REE supplies would send prices soaring.

We know this because it’s happened before… and it triggered one of the most spectacular booms in recent memory.

Back in 2010, a Chinese fishing vessel was sailing in disputed waters when it collided with Japanese coast guard patrol boats. The collision happened in waters claimed by both Japan and China.

The Japanese arrested the Chinese captain. China demanded his release, but Japan refused.

This sparked a major diplomatic dispute between the two countries. In retaliation, China abruptly cut off all REE exports to Japan. It also cut global exports by 40%.

The average price of REEs skyrocketed by over 20 times.

Over the next couple of months, companies in the industry went up many times higher.

This one incident caused a veritable mania in REE stocks that lasted for nearly a year.

That scuffle between China and Japan showed that China is ready to use its REE monopoly as a weapon to get what it wants…

And we know what happens when China uses it.

Fast-forward to today…

As tensions between the US and China escalate, it’s only a matter of time before the REE card gets played again. And this time, I expect it to be even more dramatic than the previous boom.

Recent events suggest it could be imminent.

If you’ve been anywhere near a radio… computer… or television since the summer of 2016, when then-presidential candidate Donald Trump first laid out his plans to battle China’s "unfair" trade policies, you know the basics of the trade war.

It’s the most urgent aspect of the US-China confrontation right now.

As you may have seen in the news, the trade war is spiraling out of control as each side escalates the conflict.

With the context of the trade war and Thucydides’ Trap in mind, China has stated loud and clear that it won’t hesitate to play the REE card.

Threats to restrict REE supplies have been plastered across Chinese media recently.

Further underlining the message, in May President Xi made an unusual visit to a state-supported complex in Ganzhou, which is known as the "Kingdom of Rare Earth" for its rich REE deposits.

It’s not every day that China’s No. 1 shows up at a dirty mine in the middle of nowhere. The timing of the trip was no accident. It was meant to send a message to the US.

As tensions rise, China will inevitably play the REE card and act to restrict supplies, just as it has done in the past. That will send REE prices – and the shares of REE companies – to the moon.

Given recent and unprecedented developments, that could happen imminently. The time to get positioned for big profits is now.

The best way to get exposure to rising REE prices is to invest in shares of REE-related companies.
Bottom line, China-US tensions are destined to get worse as the trade war and Thucydides’ Trap play out.

REEs are going to come into play during this confrontation, and that is going to be bullish for REE prices… and the companies involved.