Global supply chains

Supply chains are undergoing a dramatic transformation

This will be wrenching for many firms, argues Vijay Vaitheeswaran

TOM LINTON, chief procurement and supply-chain officer at Flex, an American contract-manufacturing giant, has his finger on The Pulse. That is the name of his firm’s whizzy command centre in California, which is evocative of a Pentagon war room. The kit allows him to monitor Flex’s 16,000 suppliers and 100-plus factories, producing everything from automotive systems to cloud-computing kit for over 1,000 customers worldwide.

Mr Linton is one of the acknowledged kings of the supply chain—the mechanism at the heart of globalisation of the past few decades by which raw materials, parts and components are exchanged across multiple national boundaries before being incorporated into finished goods.

Ask him about the future, however, and he answers ominously: “We’re heading into a post-global world.”

A few years ago that would have been a heretical thought. The combination of the information-technology revolution, which made communications affordable and reliable, and the entry of China into the world economy, which provided bountiful cheap labour, had transformed manufacturing into a global enterprise. In his book “The Great Convergence”, Richard Baldwin argues that the resulting blend of Western industrial know-how and Asian manufacturing muscle fuelled the hyper-globalisation of supply chains. From 1990 to 2010, trade boomed thanks to tariff cuts, cheaper communications and lower-cost transport.

The OECD, a think-tank for advanced economies, reckons that 70% of global trade now involves global value chains (GVCs). The increase in their complexity is illustrated by the growth in the share of foreign value added to a country’s exports. This shot up from below 20% in 1990 to nearly 30% in 2011.

Western retailers developed networks of inexpensive suppliers, especially in China, so that they in turn could deliver “everyday low prices” to consumers back home. Multinational corporations (MNCs) that once kept manufacturing close to home stretched supply chains thin as they chased cheap labour and economies of scale on the other side of the world. Assuming globalisation to be irreversible, firms embraced such practices as lean inventory management and just-in-time delivery that pursued efficiency and cost control while making little provision for risk.

But now there are signs that the golden age of globalisation may be over, and the great convergence is giving way to a slow unravelling of those supply chains. Global trade growth has fallen from 5.5% in 2017 to 2.1% this year, by the OECD’s reckoning. Global regulatory harmonisation has given way to local approaches, such as Europe’s data-privacy laws. Cross-border investment dropped by a fifth last year. Soaring wages and environmental costs are leading to a decline in the “cheap China” sourcing model.

The immediate threat comes from President Donald Trump’s imposition of tariffs on America’s trading partners and renegotiation of free-trade agreements, which have disrupted long-standing supply chains in North America and Asia. On June 29th, Mr Trump agreed a truce with Xi Jinping, China’s president, that temporarily suspends his threatened imposition of duties of up to 25% on $325bn-worth of Chinese imports, but leaves in place all previous tariffs imposed during the trade war. He threatened in May to impose tariffs on all imports from Mexico if it did not crack down on immigration, but reversed himself in June. He has delayed till November a decision on whether to impose tariffs on automobile imports, which would hit European manufacturers hard.

Look beyond politics, though, and you will find that supply chains were already undergoing the most rapid change in decades in response to deeper trends in business, technology and society.

The rise of Amazon, Alibaba and other e-commerce giants has persuaded consumers that they can have an endless variety of products delivered instantly. This is putting enormous pressure on MNCs to modify and modernise their supply chains to keep pace with advancing innovations and evolving consumer preferences.

Arms race

The biggest force for change is technology. Artificial intelligence (AI), predictive data analytics and robotics are already changing how factories, warehouses, distribution centres and delivery systems work. 3D printing, blockchain technologies and autonomous vehicles could have a big impact in future. Some even dream of autonomous supply chains requiring no human intervention.

However, technological advances also raise the spectre of an arms race in supply-chain security.

Aggressive private hackers and state-sponsored cyber-warriors appear to have the upper hand over beleaguered corporations and governments. Recent headlines have focused on America’s crackdown on Huawei, a Chinese telecoms giant. But the issues involved go far beyond one firm, given that much of the world’s electronics-manufacturing and hardware innovation takes place in China.

If a technology cold war breaks out, it would smash today’s highly integrated technology supply chains and force an expensive realignment. It may even lead to a bifurcation in the rollout of 5G, a new telecoms-network technology that is the essential enabler of coming marvels such as the internet of things (IOT). With the proliferation of inexpensive sensors, the IOT will allow homes, factories and cities to be digitally monitored and managed. A “splinternet of things” (in which America followed one standard and China another) would not only be costly and inefficient, it would also fail to address legitimate security concerns about future cyber-threats in the age of 5G.

Even if Huawei is eventually spared, and the truce in America’s trade war with China turns into a frosty peace, the era of frictionless supply lines flowing from Shenzhen to San Francisco and Stuttgart has ended. As globalisation is transformed into something messier, the consequences for MNCs and the world economy could be momentous.

This report will show that supply chains were already becoming shorter, smarter and faster before politicians started taking a hammer to the trading system. Given today’s riskier world, supply chains will need to become safer too. This transformation threatens firms that have entrenched supply networks, but it also presents opportunities for those that adapt nimbly.

Donald Trump’s boom will prove to be hot air

His policy of regressive Keynesianism shows the Republicans have given up on fiscal responsibility

Martin Wolf

“The economy has come roaring back under President Trump.” Thus reads a statement on the White House website. This claim needs sober evaluation.

The conclusion is that the economy has responded to a big fiscal stimulus roughly as the best forecasters predicted. That upsurge is unlikely to last. The big tax cuts have, as intended, hugely benefited owners of corporations. But they have certainly not paid for themselves. They have left the long-term fiscal position fragile, instead. That Republicans are happy with this is noteworthy. Given their posturing during the Obama era, it is also hypocritical.

Perhaps the simplest conclusion is that a fiscal stimulus works, even at a late stage in the economic cycle. According to Jason Furman, chairman of the council of economic advisers under Barack Obama and now at Harvard University, the stimulus was roughly 1.2 per cent of gross domestic product. A joint paper with Robert Barro, also at Harvard, published in March 2018, forecast that this would boost the rate of growth by 1.1 percentage points in 2018 and 2019. So far, this seems in line with outcomes.

Thus, the US economy’s trend rate of growth was 2.2 per cent from the first quarter of 2009 to the first quarter of 2017 — the years of post-crisis recovery under Mr Obama. Actual year-on-year growth has risen to about 3 per cent since the second quarter of 2018. Thus, the economy has indeed accelerated in the short term.

This acceleration has brought with it additional falls in unemployment. The unemployment rate fell from 4.7 per cent to 3.7 per cent between January 2017 and June 2019. That is the lowest since December 1969. Those low unemployment rates helped cause an inflationary upsurge in the 1970s. Will it be any different this time?

Happily, a similar upsurge has not occurred so far. There has been a modest rise in the growth of average hourly earnings of private employees, from 2.4 per cent in the year to January 2017 to 3.1 per cent in the year to June 2019. But this rate has stabilised over the past year. In real terms, average weekly earnings rose just 1 per cent in the year to May 2019. If the tax cuts brought much to working people, it is certainly more via additional jobs than rising real earnings.

Yet participation in the labour market by men and women aged between 25 and 55 is still below past peaks. Prime-age male participation was 89 per cent in June 2019, against 96 per cent in early 1970. For women, it was 76 per cent in June 2019, against a peak of 77 per cent in April 2000. The decline in unemployment has to be put in this context. Labour force participation has fallen dramatically in the case of prime-age men. The secular rise in participation stopped two decades ago in the case of prime-aged women.

The main impact of the tax cuts in the economy is on post-tax profits, as one would expect. The effective tax on profits collapsed to 10 per cent in early 2018, from 19 per cent in the third quarter of 2016. This is another big fall in a history of declines: in the early 1950s, the rate peaked at 50 per cent.

The big economic justification for lower taxes on corporations is that it would raise investment.

The ratio of real non-residential private fixed investment to GDP was 13.8 per cent in the first quarter of 2019. This is only 0.8 percentage points higher than in the last quarter of 2016. It is also well within the historic ratios. The paper by Profs Barro and Furman suggest that the changed tax treatment of corporations should have a modest upward effect on growth, largely through higher cumulative investment.

But the impact would only be to raise GDP over 10 years by 0.2-0.4 percentage points. In a recent paper, Prof Furman suggests even this might be an overestimate, in terms of US real national incomes rather than GDP, once one takes the payments to foreigners needed to fund higher investment and fiscal deficits into account.

While the long-term effect on growth seems nugatory, the impact on the finances of the federal government is not. That may well be the main point, for congressional Republicans at least. Tax cuts do not pay for themselves. But they help “starve the beast”, in common Republican parlance. The ratio of federal receipts to GDP fell to 17 per cent in the first quarter of 2019, against 18.8 per cent two years before.

The gap between receipts and spending also hit 5.5 per cent of GDP in the first quarter of 2019 at what must be close to the peak of the cycle. This could be justified if these deficits were funding investment. But they are doing no such thing. The fiscal incontinence of the Republicans will also have told Democrats that fiscal responsibility is senseless. That realisation will have big long-term effects.

Donald Trump’s main policy has been a regressive form of Keynesianism, masked as corporate tax reform. The latter delivered huge gains to shareholders. It has brought a strong short-term stimulus, which has had good effects on unemployment. Whether current unemployment rates are sustainable is unknown. But they cannot go on falling forever.

The effects on long-term growth are likely to be modest, though running the economy this “hot” just might generate an upsurge in investment and so growth. Given the pressure on the Federal Reserve to keep pouring on petrol, this could end in tears, with higher inflation and interest rates and damaged fiscal and monetary credibility.

It is too soon to laud Trumponomics. But it is not too soon to note where the US is heading. It is hard to imagine anybody standing up for fiscal prudence. The choice is rather between rightwing and leftwing Keynesians. In the long run, that is likely to end badly. But that could be a very long run.

The threat of a US-China currency war
Were Beijing to sell off its Treasury holdings, extreme market volatility would follow
John Plender

Presidents Donald Trump and Xi Jinping: the latter's readiness to finance the former's burgeoning fiscal deficit is clearly waning © AFP

From trade war to currency war is a perilously simple step. As the US-China tariff skirmish escalates and the renminbi sinks against the dollar, there is a growing risk that President Donald Trump may take it. The more specific concern in the markets is that the US administration could intervene directly to weaken the dollar. While the yen, the euro and sterling are all potential targets, the greatest scope for global financial instability relates to the US and China.

In a strikingly vivid phrase Paul Volcker, former chairman of the Federal Reserve, once referred to the close financial ties between the US and China as a potentially “fatal embrace”. Those ties include the fact that China holds more than $1tn of US Treasury securities. Against the background of rumbling trade friction between the two countries, the obvious nightmare scenario would be the weaponisation of Chinese official foreign exchange reserves against the US.

There are straws in the wind. In the three months to the end of May, China’s holdings of US government IOUs were reduced by $20.7bn to $1.1tn. This is still the biggest foreign stake in the US Treasury market, although it has shrunk by $81bn since June last year. But over the longer run Chinese ownership of outstanding US Treasuries has fallen from a peak of 14 per cent in 2011 to 7 per cent at the latest count. Clearly, Beijing’s readiness to finance America’s burgeoning fiscal deficit is waning. The question is how sinister an interpretation to put on this evacuation from the world’s biggest sovereign debt market and whether everyone is too complacent about the threat of weaponisation.

The fear that China would use financial leverage to influence US policy is not entirely without foundation. Back in 2011 Ding Gang, a senior editor at the People’s Daily, argued in an editorial that Beijing should use its financial clout to teach the US a lesson in response to its arms sales to Taiwan. Yet this threat left the US Department of Defense unbothered. In a 2012 report it argued that the threat was not credible because the use of Treasury securities as a coercive tool would have limited effect and would do more harm to China than the US.

The Pentagon had a point, in that China could not dump Treasuries without pushing up yields (and thus reducing capital values), leading to big losses on its holdings. If the proceeds were repatriated, the losses would be compounded by a surging renminbi and a falling dollar. 

Now, Treasury yields have actually been falling while Beijing has been selling. That suggests that the pool of domestic and foreign savings supporting what is perceived to be the world’s safest collection of assets is so great that the Chinese divestment is no more than a blip.

Equally important, alternative havens for Chinese official reserves are less than compelling. There is a limit to how much the gold market can absorb, while the eurozone sovereign debt market is fragmented and relatively illiquid. Moreover, a growing share of eurozone government debt shows a negative yield, unlike the US.

There is, nonetheless, an important caveat in any analysis of Chinese capital flows. The US Treasury’s international capital data releases do not capture all the changes in China’s official reserves portfolio. Holdings can be moved to custodial accounts in Luxembourg or Belgium. It is possible, too, that Beijing is trying to enhance the return on its reserves by switching to other, higher yielding dollar assets.

The real question that remains is, how does the Communist party leadership in Beijing perceive its interests, particularly at this fraught stage in trade negotiations with Mr Trump? The one certainty is that any abrupt decision to sell off China’s Treasury holdings would precipitate extreme volatility across global markets. So it is important to note that Chinese leaders fear instability above all else.

In the end, the real force of Mr Volcker’s reference to a fatal embrace lay in an unintended consequence of interdependence. Before the global financial crisis China’s excess savings, which were reflected in the build up of its official reserves, were an important contributory factor in the US credit bubble, whose collapse in 2007-8 came close to precipitating a 1930s-style depression. But to be fair to the Chinese, their huge fiscal and monetary pump priming in 2009-10, albeit carried out purely in their own interest, helped put the global economic show back on the road. What emerges from this story, at the risk of stating the obvious, is that everything about economic interdependence is double-edged.

Gold Headed To $2,000 On Fed Capitulation

by: Atlas Research

- For the last decade, the monetary “experts” assured us that QE and ultra-low interest rates were a temporary crisis measure that could be reversed.

- 2018 revealed the truth – that the Fed cannot normalize monetary policy without crushing financial markets.

- 2019 has shown that policymakers have no political will for tighter monetary policy. Radical easing measures is the new normal.

- Global central banks are getting ahead of this trend with the most aggressive gold purchases on record.

The precious metals bull market is on, and I see new record highs in both gold and silver prices looming on the horizon.
The fuel for this bull market will come from one word: capitulation. The U.S. central bank has officially capitulated on raising interest rates and unwinding its multi-trillion dollar balance sheet.
The experts assured us that the radical monetary easing measures of the post-2008 world were temporary responses to an extraordinary crisis. But now, it’s clear that ultra-low interest rates and a bloated Fed balance sheet have become the new normal.
As the world comes to grips with this new era of permanently radicalized U.S. monetary policy, investors will flock into precious metals as the ultimate store of value. To appreciate the significance of the Fed's capitulation on normalizing monetary policy, and what it means for precious metals prices, let’s first step back and review how we got here.
The U.S. Dollar Runs on Confidence
The Federal Reserve (FED) has acted as the steward of our nation’s monetary system since its founding in 1913. Like all banks, the Fed’s balance sheet contains assets and liabilities. The assets include U.S. Treasuries and mortgage bonds, which the Fed purchases by creating liabilities – from thin air – in the form of U.S. currency. The fact that our currency exists as the Fed’s liability is why you see “Federal Reserve Note” on your U.S. dollar bills.
If you look on the bottom of this 100-dollar bill, notice what it entitles you to – “One Hundred Dollars”. What this literally means is that today’s Federal Reserve Notes are backed by… more Federal Reserve Notes. So if you bring your 100-dollar bill to the U.S. Treasury, guess what you get for it? 100 dollars. That means the U.S. currency is a figment of our collective imagination – nothing more than a piece of paper with fancy artwork and dead President portraits.
But it wasn’t always this way…
Before 1971 when Nixon closed the gold window, the U.S. currency was backed by physical gold and silver. You can see this in the currency itself, including the following one-dollar bill from 1957.
Notice the difference in language on the top and bottom of the currency – instead of a “note” it’s a “silver certificate”. And on the bottom, you can see that this silver certificate was redeemable in physical silver:
So what’s the big deal, why does this all matter? The critical difference between hard money (i.e. redeemable in gold and silver) versus pure fiat money (i.e. backed by government decree and only redeemable in more paper currency) is the inherent value and limited supply of silver and gold versus the lack of tangible value and unlimited supply of paper currency.
In other words, the value of today’s U.S. fiat currency relies purely on confidence. And when confidence evaporates – typically during a period of rapid currency creation – the value of that currency can implode. Going forward, all signs point towards a major loss in the confidence of the U.S. currency. It all centers around the Fed’s balance sheet – which you’ll recall contains assets on one side and liabilities (our currency) on the other.
The Most Reckless Monetary Expansion in U.S. History
From its 1913 inception up until 2008, the FED gradually grew its balance sheet to roughly $900 billion. But when the Great Financial Crisis struck in 2008, the central bank bailed out the private banking sector by purchasing trillions in mortgage bonds. The Fed also purchased trillions in U.S. Treasures, with the stated aim of pushing down interest rates and jump starting sluggish economic growth. All told, in less than ten short years, the Fed’s balance sheet exploded to $4.5 trillion at the peak– or a 400% increase – in the most aggressive and reckless monetary expansion in U.S. history:
And remember, the Fed purchased these assets by creating liabilities in the form of U.S. currency. So over the same period, we saw a similar 400% increase in the U.S. monetary base – which surged from $800 billion in 2008 to as high as $4 trillion at its peak in 2014.
All along the way, critics worried that this reckless growth in the monetary base would eventually wreak havoc on the value of the U.S. currency. So far, we've avoided this fate, as much of the growth in the monetary base sits idle on private bank balance sheets as excess reserves. But this monetary kindling could eventually fuel an inflationary firestorm, if banks ever begin lending these reserves into the real economy. And if this money stays in the system long enough, it’s only a matter of time before such an event materializes.
Meanwhile, with the U.S. central bank becoming one of the largest buyers of U.S. Treasuries since 2008, critics also argued that we were simply monetizing government debt (i.e. financing government deficits with printed money). Normally, this type of financing scheme is reserved for banana republics, but not the good ole U-S of A. If this became the new normal, critics argued, it would destroy the confidence in the long-term value of the U.S. currency.

For the last decade, the “experts” told us not to worry… they claimed these problems would only materialize if the Fed kept the assets on its balance sheet permanently. When the Fed eventually unwound its balance sheet– and the experts assured the Fed would – then we could simply forget this whole monetary experiment ever happened in the first place.
Just think back to your high school days, when your parents left town for the weekend. Surely you could throw a wild party for you and 200 of your closest friends, so long as you cleaned the place up before your parents got home… no harm, no foul, right?
Essentially, the Fed used this same rationale to explain why we should should not fear the prospects of inflation or debt monetization. It was all spelled out in official communications, including the following excerpt from a 2013 Fed report rhetorically titled: Is the Fed Monetizing Government Debt?:
“… the FOMC has made unusually large acquisitions of longer-term securities, including Treasury debt…If this accumulated Treasury debt is supposed to be permanent, then it is reasonable to expect that the corresponding supply of new money would also be permanent … Thus, under this scenario, money creation becomes a permanent source of financing for government spending. 
On the other hand, if the Fed's recent increase in Treasury debt holdings is only temporary (an unusually large acquisition in response to an unusually large recession), then the public must expect that the monetary base at some point will return to a more normal level… Under this scenario, the Fed is not monetizing government debt…”
This line of logic was reiterated by former Fed Chair Ben Bernanke even went on 60 Minutes in order to mollify public concerns about the reckless monetary expansion during his tenure (even though he contradicted previous remarks made on the very same program, as ridiculed in this terrific clip from Jon Stewart's Daily Show).
In other words, the Fed convinced the world not to worry, that it would have no trouble putting the monetary genie pack into the bottle. Once the economy found its footing, the Fed could simply raise interest rates and dump trillions in mortgage bonds and government securities off of its balance sheet and back onto the open market. After which, we could simply forget the whole thing ever happened and move on with our lives.
2018 Showed that Financial Markets Remain Hopelessly Hooked on Cheap Money
The Fed's plan to normalize monetary policy when the economy recovered sound like a great plan on paper. But to quote the great Mike Tyson… “Everyone has a plan until they get punched in the mouth.”
And in 2018, financial markets delivered the proverbial face punch when the Fed implemented its plan in earnest, with four interest rate hikes and selling off nearly half a trillion in securities from its $4.5 trillion balance sheet. The following chart of 2018's global asset class returns best sums up the carnage unleashed from this monetary tightening effort:
And the fallout wasn’t limited to falling asset prices. The Fed’s tightening campaign effectively froze the corporate bond market to the point where, in December of last year, not a single junk bond sale went through for the entire month. The last time we saw anything of this magnitude was - any guesses? - the Fall of 2008.
In other words, the façade of our financial system – erected upon the fragile foundation of easy money policies since 2008 - crumbles the moment those easy money policies go away.
Given the carnage from 2018’s monetary tightening, it’s no surprise that 2019 became the year of Fed capitulation. Last week, this capitulation became official, when - after one of the most tepid rate hiking cycles in history - the Fed began cutting interest rates once again at its July FOMC meeting.
Meanwhile, after selling down only 20% of its massive $4.5 trillion balance sheet, the Fed put an end to its balance sheet normalization plan.
So we now know that the assurances from Fed officials about the “temporary” nature of easy money policies turned out to be just as wrong as their other predictions. Today, we’re stuck with a $3.2 trillion monetary base, which is about 300% larger than the pre-crisis level of $800 billion. In other words, we should very much fear inflation going forward, because this money isn’t going away:
As the world increasingly wakes up to the fact that the U.S. monetary base cannot return to normal levels, dollars will increasingly flow into gold as a store of value. Of course, there’s plenty of naysayers who dispute the inherent value of gold as a store of monetary value. After all, it’s just a worthless rock, right?
But these naysayers probably can’t explain why the world’s central banks just buy 374.1 metric tons of gold in the first half of the year – the fastest pace on record. That seems to be a lot of money spent on something with no intrinsic value…
The truth is, these central banks know what’s coming. The last 18 months revealed that 1) the U.S. can't normalize monetary policy without crushing financial markets and 2) U.S. policymakers have zero political will to tolerate a correction in financial markets.
And remember, we're in an environment of sub-4% unemployment and record high stock prices. So you can only imagine what’s coming down the pike when the inevitable next recession strikes.
During the next downturn, the stage is set for even more radical monetary policy measures. The possibilities include negative interest rates, widespread debt write-offs - both public and private - and even outright "helicopter money." The modern monetary theory crowd will likely get their chance to test the theory of limitless money printing, and it won't end well.
Global central banks see the writing on the wall. Given this backdrop, it’s no surprise why gold prices recently broke out to a new five year high. And as the world comes to grips with the new normal of ultra-low interest rates and a bloated Fed balance sheet, I see gold prices hitting new record highs of $2,000 per ounce and more in 2020 and beyond.
In the Atlas Portfolio Series blog, we’ve been positioning for this emerging new precious metals bull market with silver and one of my favorite miners – Pan American Silver (PAAS). We recently closed out an options trade in PAAS for a 40% return in under two weeks.
Going forward, investors will likely benefit from owning gold (GLD), silver (SLV) and high-quality miners like Pan American Silver (PAAS) as we enter a new secular bull market in precious metals.

Command of the Sea

By George Friedman

Command of the sea is the foundation of American national security. Adm. Alfred Thayer Mahan, the greatest strategist in American history, identified it as the core American interest (though he wrote before the war on terrorism began and before the development of nuclear weapons). The United States, he argued, can be threatened only by an enemy naval force that could both invade its territory and curb its access to the oceans. Therefore, the foundation of America’s national security, as with Britain’s, had to be the command of the sea.
Indispensable Sea Lanes
Command of the sea guarantees security and trade. Ancient Rome certainly understood as much, focused as they were on controlling Mare Nostrum (or Our Sea, referring to the Mediterranean), which forced North African threats like Carthage to attack Rome on its flanks and ensured access to Egyptian crops. The land routes around the Mediterranean were powerful but slow. The naval routes were rapid but lighter, and commercially, they were indispensable.

China and Iran are now trying to secure their sea lanes, or at least deny others access to them. For China, now a massive trading power, access to the world’s seas is an economic necessity. Its fear is that the United States could try to blockade China and, in doing so, strangle the Chinese economy (and keep in mind, the worst-case scenario is historically not the least likely one). Iran, which is hobbled by U.S. sanctions, does not have the political or naval power to break the blockade, but it does have the wherewithal to launch a counter-blockade of the Strait of Hormuz. The vast amounts of oil flowing through the strait are essential to many U.S. allies, and successfully blocking the strait would cause an economic crisis followed by a crisis in the alliance. Sanctioning Iran, therefore, might prove too costly for the United States. So long as trade is carried out on the seas, control of the seas is essential.

Historically, command of the sea depended on surface vessels, powered by oars, sails, coal, oil and so forth. The operational principle of national power was the possession of a sufficient fleet to overwhelm the enemy primarily in size and weaponry. The high point of this ancient concept of naval warfare was the battleship, a massive and expensive vessel, carrying a handful of guns able to fire large munitions at long range. Surface warfare had reached its peak with the battleship. Its cost would cripple a mid-sized country’s economy. It could defeat any ship it encountered, save another battleship. The race was in size, armor and munitions, and whichever country had the most could protect its maritime interests.

The foundation of naval tactics was therefore the surface vessel against the surface vessel. This was replaced not by any advancement in the power of battleships but by the introduction of a new concept in naval warfare: air power. Whereas battleships fought by firing salvos of large shells at enemies, aircraft could fire small explosive shells that impacted the surface and torpedoes that hit battleships below the waterline. Another threat came from submarines.

Starting with the British attack on the Italian fleet at Taranto, and culminating with the Japanese attack on Pearl Harbor, vessels designed to carry torpedoes and bombs devastated battleships in harbors. Very rapidly, the center of gravity of naval warfare shifted to the aircraft carrier and was supplemented by the submarine, which was designed to break the supply chain in the North Atlantic and Western Pacific.

This combination of aircraft carriers and submarines had been at the heart of naval warfare for nearly a century, but new munitions eventually challenged their primacy. Specifically, the introduction of precision-guided munitions increased the vulnerability of the carrier. These are not ballistic missiles; once fired, their direction could be corrected, making them much more accurate than the older missiles. In 1967, a Soviet Styx missile fired from Egypt sank an Israeli destroyer, the Eilat. The accuracy was stunning, as was the warhead’s effect.

The sinking of the Eilat forced many to second guess the aircraft carrier. The assumption had been that fighters could provide protection to carriers. Enemy aircraft had to fly into the combat air patrol’s space to deliver iron bombs and torpedoes. The Eilat incident showed that this was not necessary. A PGM fired from shore – or by an aircraft standing outside the air defense space of fighters, anti-air guns and missiles – could sink or wreck ships.

One way to defend against this was to expand the fighter space, but as this happens, it outstrips the availability of fighters. The focus turned, then, from shooting down attacking planes to destroying incoming missiles. Systems like the American Aegis were created, at enormous expense, to do so. No system is perfect, so keeping attackers at a distance remained critical. The cost of this was a massively increased number of advanced vessels designed to provide air defense and anti-submarine warfare capability. The carrier battle groups cost many billions of dollars in initial development and maintenance, to allow 30-70 attack aircraft to fly toward a target and fire PGMs into a similar defensive array.

The aircraft carrier had begun to look like the battleship, with pyramiding costs designed to provide defense. It was similar in a second sense. The PGMs evolved, partly in accuracy but mostly in speed and agility. This forced the air defense systems to evolve, too. The cost of evolving the PGM was much lower than the cost of evolving the defensive system, so as the cost of maintaining the security of the carrier battle group rose, the strike capability – the tonnage that could be delivered against an enemy – did not keep pace.
Introducing Hypersonics
The crisispoint for the carrier has been reached with the emergence of hypersonic missiles, which can reach speeds of over five times the speed of sound, with maneuverability. The range of these missiles has expanded the combat envelope substantially, forcing extreme upgrades to the air defense system. Some claim that the explosives these missiles carry could not sink a carrier. But given their precision, they could render the carrier inoperable during battle by attacking key elements of the flight deck.


It is for this reason that the Russians and Chinese have trumpeted their hypersonic systems. They represent a challenge to the American command of the sea, so long as the foundation of the system is surface warships – and even submarines become more vulnerable as the oceans become more transparent to the hypersonic missile sensors.

As the range of the hypersonic missiles increases and their cost decreases, the dangers to surface warships rise. Defenses are possible, but the missile-versus-missile paradigm becomes increasingly risky. A less risky solution is to render the missiles inoperable. This can be done by targeting the guidance system, which requires the general location of the enemy, and the onboard terminal guidance system. It is the intelligence on the general location of the ship that is the failure point.

To locate a fleet, it is necessary to have some reconnaissance. This can involve aircraft, unmanned aerial vehicles or space-based systems. Aircraft can stumble into the carrier’s kill zone. UAVs can be shot down or, worse, their electronics corrupted, their signals spoofed and so on. Nothing is without risk, but the primary strategic platform for monitoring an ocean must be space based. It alone has the breadth of vision to provide useful guidance to hypersonic missiles that must have a vast range to be most effective.

If the key to control of the sea becomes the hypersonic missile, it is like the carrier-based aircraft, or the battleship’s guns. It is the deliverable. But just as the carrier-based plane or battleship guns must have targeting information, so must the hypersonic missile, wherever it is based. The primary source of strategic targeting must be based in space. And that means that command of the sea will depend on a space-based system that will control munitions. The aircraft carrier began to separate the platform and the munitions it delivers. The hypersonic missile radicalizes this by taking the targeting platform away from the sea into space, and the munition to be delivered away from the ship and to the land.

As the range increases, deploying hypersonics at sea or even on submarines is dangerous. The sea makes it very hard to hide a firing platform. Land is full of folds and holes and vegetation, all supplemented by manmade confusion. Identifying these will also require space-based reconnaissance and range to strike. War must now begin by blinding the enemy, and that means taking out reconnaissance satellites and then filling the gap with UAVs. War is initiated with space-based attacks, and the control of space becomes the foundation of control of the seas. However, with hypersonic missiles being located on the ground, there must be attacks on land-based launchers, which, mapped out by satellites, must become mobile and stealthy to survive.

Command of space is becoming the foundation of the command of the sea. Those who can see enemy missiles can destroy them and do so rapidly with longer-range hypersonics. Space denial, therefore, would be essential to protecting merchant vessels from enemy attack. We are not far from this reality. The satellites and UAVs exist, and new generations of hypersonic missiles are appearing. The command of the sea shifted from the surface of the sea to the air and is now shifting from the air into space. It does not change the core geopolitics, but it does transform war.

Does the G20 Still Matter?

The first few gatherings of the G20, at the height of the global financial crisis, yielded concrete results, and seemed to promise an auspicious future for global governance. But in the years since, the group has increasingly replaced action with empty talk, piling ever more goals on top of the unmet objectives of summits past.

Jim O'Neill


LONDON – When the G20 leaders held their first summit in late 2008, many welcomed what looked like a diverse, highly representative new forum for crafting common solutions to global problems. The group acquitted itself well in responding to the global financial crisis, and, for a while, its emergence as a forum for international policy coordination seemed like one of the only silver linings of that mess.

I was certainly among those applauding the G20’s initial achievements. Since 2001, when I identified the rise of the BRIC countries (Brazil, Russia, India, and China) as a key feature of the twenty-first-century world economy, I had been calling for a major overhaul of global-governance structures. As I argued at the time, the continued dominance of the G7 (Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States) was increasingly out of step with the complex world of the early 2000s. To this day, the G7’s exclusion of China is a glaring omission, made worse by the presence of so many European countries, most of which share a currency and abide by the same fiscal- and monetary-policy rules.

Unfortunately, following the G20’s summit in Osaka, Japan, last month, I cannot help but wonder whether that gathering, too, has lost its purpose. Indeed, the only relevant development to come from the summit was a agreement on the sidelines between US President Donald Trump and Chinese President Xi Jinping, who brokered yet another “truce” in their countries’ trade war.

Part of the problem, of course, is that global governance in general has been marginalized, now that the US has abdicated its role as the custodian of the international order. But there are also issues with the G20 itself. On one hand, the group looks like an appropriate vehicle for facilitating global dialogue. Its membership represents around 85% of global GDP and comprises most of the leading emerging economies, including those that have not adopted Western-style liberal democracy. With the exception of Nigeria, Africa’s largest economy and most populous country, the countries that one would expect to have a seat at the table do. And in the future, one could imagine Vietnam and a few others joining them.

On the other hand, while the G20 has been very good at issuing grandiose communiqués to acknowledge the existence of global challenges, it has proven utterly incapable of advancing any solutions to them. To be sure, one could argue that it isn’t realistic to expect a bunch of bureaucrats to fix everything that is broken in the world. If anything, it is the duty of activists, entrepreneurs, and other creative thinkers to pressure and persuade political leaders on the need for change. And yet, when it comes to problems that can be addressed only cooperatively at the global level, there is no alternative to bodies like the G20. Even if political leaders have adopted all the right ideas, they still need a forum for turning those ideas into coordinated policies.

To my mind, there are two barriers standing in the G20’s way. First, though it is representative, it is also far too large. As I have argued since 2001, what the world really needs is a more representative G7, comprising the US, Japan, the European Union, and the BRIC countries. This new grouping would reside within the G20 and represent three-quarters of global GDP. While Canada and a post-Brexit UK would lose some of their current influence, they would have no less of it than similarly situated countries such as Australia. At any rate, they need not worry: there is no reason to expect a diplomatic overhaul of this scale anytime soon.

The G20’s second deficiency is that it (as well as the G7) lacks an objective framework through which to set goals and measure progress toward them. Since the group’s initial success a decade ago, its agenda has been fluid, with each host country adding something new to the mix at every annual gathering. In the case of the Osaka summit, the Japanese government introduced the goal of universal health care.

No one doubts that universal health care is a worthy cause. But nor has the G20 actually done anything to help individual member states expand the provision of health care. Worse, the time spent paying lip service to this new objective could have been used to discuss outstanding issues such as antimicrobial resistance, which was added to the G20 agenda in 2016. The language about AMR in the latest communiqué was notably similar to that of previous summits, which suggests that little progress has been made.

Meanwhile, the market for new antibiotics is deteriorating rapidly. Without a concerted international response, drug-resistant superbugs could take ten million lives per year by 2050, resulting in a cumulative loss of around $100 trillion in global output. What the world needs now is action, not empty words.

Jim O’Neill, a former chairman of Goldman Sachs Asset Management and a former UK Treasury Minister, is Chair of Chatham House.