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GEOPOLITICALALPHA AnInvestmentFramework forPredictingtheFuture By MarkoPapic
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LibraryofCongressCataloging-in-PublicationData:
Names:Papic,Marko(Geopoliticalstrategist),author.
Title:Geopoliticalalpha:aninvestmentframeworkforpredictingthe future/byMarkoPapic.
Description:Hoboken,NewJersey:JohnWiley&Sons,Inc.,[2020]| Includesbibliographicalreferencesandindex.
Identifiers:LCCN2020025448(print)|LCCN2020025449(ebook)|ISBN 9781119740216(hardback)|ISBN9781119740230(adobepdf)|ISBN 9781119740223(epub)
Subjects:LCSH:Investmentanalysis.|Geopolitics—Economicaspects.| Economicforecasting.|Investments.
Classification:LCCHG4529.P372020(print)|LCCHG4529(ebook)|DDC 332.67/253—dc23
LCrecordavailableathttps://lccn.loc.gov/2020025448
LCebookrecordavailableathttps://lccn.loc.gov/2020025449
CoverDesignandIllustration:TataWijanaWarsita
AuthorPhoto:©StevenDrobny
PrintedintheUnitedStatesofAmerica. 10987654321
Thisbookisdedicatedtothecountrythatnolongerexists. Pjevajnekte ˇ cuju,koneslušapjesmusluša´ceoluju!
Foreword Montreal.February2017.
Acold,dark,andice-stormynight.
ImetMarkoPapicforthefirsttimeoverdinnerataspotheenthusiasticallycalled“thecoolestrestaurantintown.”Uponentering,Ifound adarkandemptyrestaurantsaveforabartender,awaiter,a mâitred’, and alonecustomersittinginthebackcorner.Istartedstrategizingapolite earlyexit.Butthefoodanddrinkswereincredible,andweproceeded tohaveanexcellent,wide-rangingconversation.Westayedlateandgot totallyblasted.ItwasthefirstofmanytimesIwouldobserveMarko makeacorrect,out-of-consensuscall.
WithinminutesofmeetingMarko,Iknewhewasunique.Mysingularskillissniffingoutqualityfromcrapandgatheringthegoodones aroundme–beitfindingnewmoneymanagerstoruncapitalforour institutionalclients,bringingtogethersmartinvestorsonadeal,backing foundersofnewfinancialtechnologycompanies,orconveningthemost interestingpeopleintheworldataneventinsomefar-flunglocation. Ialsoseekoutthosewithuniqueskillsandtrytopersuadethemtojoin theClocktowerGroupteam.
BythetimeImetMarko,I’dbeenlookingforachiefstrategistfor awhile.Ineededsomeonetoactlikeabasketballcenter,abigmanin themiddletogeltheteam.Iwaslookingforabeautifulmindtosit ontopofouruniqueandexclusiveinformationflow,thenchannelit intoacoherentformforourclients.Atfirst,Ilookedforthetypical economist.Overthepast40years,bondmarkets,centralbankers,and financeministersdrovemarkets–andtheworld.ItwastheLordsof FinanceandtheCommitteestoSavetheWorldwhopulledthepuppet strings,andthe alpha layincorrectlyforecastingtheirnextmove. Enter2016.
ThepassingoftheBrexitreferendumandtheelectionofDonald Trumpmarkedaseachangeinthemacrogame.Populistmovementsin developedcountriesdrovehomethepointthattheeraoftheeconomist andtheinterestratesoothsayerwasover.Inthepost-Trump,post-Brexit era,geopoliticsareallthatcounts.Withinterestratespeggedtothezero lowerboundfortheforeseeablefuture,theLordsofFinanceandCommitteestoSavetheWorldhaverunoutofammo.
Assuch,Clocktower’schiefstrategistneedednotbeanIvy-trained economistwithaperfectrésumécoupledwithaPhD,CFA,MBA,and othermeaninglessacronyms.Weneededsomeonenotlockedonthe movementsoftheFed&Co.,butfocusedoninternationalanddomesticpolitics.Thebattlesandpowerplayersoftoday(andtomorrow)are TrumpversusXi,theUKversusEurope,Putinversusworld,MBS, Macri,Bolsanaro,etc.
EnterMarkoPapic:ageopoliticalexpertwhogrewupgetting chasedbypacksofwilddogsincollapsingYugoslavia;whosubsequently movedtoIraq,Jordan,SwitzerlandandTexas;andwhomarrieda Tejana andsettledinCanada.Whispersofanunorthodoxgeopoliticalthinker without-of-consensusmarketviewsdriftedfromclientsandprospects. AstrategistoutofMontrealwhomoreoftenthannot,turnedouttobe right.Formany,Marko,thenihilistSerbian,wastheirfavoritestrategist. Irealizedhewasjustthestateless,unbiased,enthusiastic,uniqueidea generatorthattheteaminSantaMonicaneededtofilloutourglobal macrosquad.
AfterfollowingMarko’scallsforayearandtest-drivinghimata fewclientevents,Ispentthebetterpartof2018convincinghimthat thebeachesofSouthernCaliforniaareabetterplacethantheslopes ofMont-Tremblant.InDecember2018,Markosignedontojoin ClocktowerGroupasourchiefstrategist.In2019,hecrushedit.In January2020,Isaid,“Marko,thatwasgreat,butnowitistimetotake thetrainingwheelsoff,”andmadehimwritethisbook.I’vewritten twobooksaboutglobalmacroandwashalfwaythroughwritingmy third:thefinalinstallmentinmytrilogy.Contractwassigned,chapters wereinthecan,andanadvancewaspaid.Halfwaythrough,theworld changed.Itwastimetopasstheballtothebigmaninthemiddle.
Markotookthepassandranwithit.LikehischildhoodheroKobe Bryant(RIP),heapproachedthisbookwithinsanefocus.Hewrote chaptersfasterthanIcouldreadthem.Hedidthisallwhileproducingreportsandtalkingtoclients,seeds,founders,andpartnersontop ofatornACL/meniscus(whichheignored),workingfromhomeand homeschoolinghisthreekidsduetoCOVID-19.Mamba-style.
Markohasalottosayaboutthisbravenewworldthatrevolves aroundpoliticsandgeopolitics.Peopledeservetohearit–notjust Clocktowerclientsandfriendsbutanyonewhowantstheireyesopened totheinvisiblebarriersthatdictatethefuture.In GeopoliticalAlpha, Markomodelshowtomakewell-researched,actionableforecasts usinghisconstraint-basedframework.Alongtheway,hegiftsyou,the reader,withfunnystories,anecdotes,andhistoricalexamplescoupled withinvaluableinsightsonrelevantgeopoliticaltrends:thestateof US–Chinatensions,thefutureofEurope,theimplicationsofthe COVID-19pandemic,USelections,andotherschismsthatwilldrive worldmarkets.Ihopeyoulearnandenjoy.You’rewelcome.
StevenDrobny CEOandFounderofClocktowerGroup
Authorof InsidetheHouseofMoney and TheInvisibleHands. March2020
Currentlyunder“Shelter-in-place” orderinMalibu,Claifornia
Introduction I“TheGermanpresidentjustresigned.Wearesellingeverything.Thisisit.”
tisMay31,2010,andHorstKöhler,thepresidentofGermany,has resigned.
Isawthenewsflashacrossmyinboxinoneofthehundredsofnews itemsthatIskimmedeverymorning,butIignoredit.Ihadtriagedit, alongwithmostarticlesthatday,forthesakeofsanity;Ithoughtitwas irrelevant.
Severalhourslater,IstareatthePolycominthemiddleoftheboardroomatStratfor,theAustin,Texas–basedgeopoliticalanalysisfirmthat gavememyfirstjob.Mydecisiontoignorethisonenewsitemisabout tocostmethatfirstjob.Theknotinmystomachhasknots.
Thesaleswomanwhoseclient–alargeConnecticut-basedhedge fund–isonthelineboresaholeinthesideofmyheadwithhergaze.I almosthearherthinking, OhmyGod thisforeignkidisoutofhisdepth IhavenoideawhytheGermanpresidentresignedorwhyitis market-relevanttoahedgefund(Ihaveonlyavagueideaofwhata hedgefundisinthefirstplace).IhavenoideawhotheGermanpresident evenis!
ByMay2010,theEuroAreasovereigndebtcrisiswasalreadyinfull swing.The2008GreatRecessionhadcomeandgonewithoutthecollapseofWesterncivilization,butthingswerestilltouch-and-go.People wereonthelookoutforthenextshoetodrop.InOctober,2009,incomingGreekPrimeMinisterGeorgePapandreourevealedthattheprevious governmenthadmassivelyunderreportedthebudgetdeficit.Insteadof 6.7%,thefigurewas12.7%(laterrevisedto15.4%!).Theshoe dropped. ByDecember2009,thegreatesteconomiccrisisinthedevelopedworld sincetheGreatDepressionwasafoot.
Nobodyatmyfirmreallycared.Itwasnotthefaultofthefolksrunningtheplace;thefirmwassimplynotdesignedtocareaboutfinancial markets.Formostofthepastthreedecades,theinvestmentandgeopoliticalcommunitiesrarelycommunicated,inpartbecausetheystruggled tounderstandeachother.Theyhadbecomeover-professionalized, erectingbarrierstoentrylargelyforjobsecurity,likemedieval guilds.
WhentheEuroAreacrisishit,mymarchingordersatthefirmwere nottospendtoomuchenergyonit.IwastoldtofocusonUSballisticmissiledefenseinEuropeandsomeothergeopoliticalmattersthat nobodyoutsidetheBeltwaycaredabout.Wehadnoedgeincoveringcapitalmarkets–fewofthefirm’sanalystsunderstoodtheirown creditcardstatements.Butasthefirm’sEuropeanalyst,itwasimpossible toignoretheevolvingimbroglio.Notonlydiditfloodmyinboxwith scaryheadlinesandclientemails,butIalsosensedthatthiswasthecareer opportunityofalifetime.
Byearly2010,myowncareerhadstalledbeforeithadevenreally begun.IwasonleavefromaPhDprogramattheUniversityofTexas atAustin.Politicalsciencecourseworkandresearchwareeasy,butnot interesting.IwouldhavecoastedfortherestofmylifeteachingPoliSci 101,buttheoversuppliedlabormarketinsocialsciencePhDsmeantthat Ihadtotakewhateverjobwasavailable,evenifitdepositedmeandmy familyinsomeacademiccolonyinthemiddleofnowhere.
ItookthejobatStratforbecauseitwasbasedinAustin.Igotlucky. Theplacewasfast-paced,young,andbrutal.Ittaughtmenottowaffle,todigestinformationquickly,andtocreateknowledgeshortcuts. ButIwasstillmissingthesensethatIwasmakingadifferenceinanybody’slife.
Myfeelingofinadequacywas,inlargepart,aproductofmyjob description.Atthestartofthedecade,Europehadnotproducedgeopoliticalrisksforaquarterofacentury.ThefalloftheBerlinWall,the dissolutionoftheSovietUnion,andtheriseoftheworld’slargesttradingblocwereallepicevents,buttheywerealltailwindsinthesailsof theglobaleconomy.TherewasasensethathistoryhadendedinEurope andthatJean-ClaudeJunckerwasitsLastMan.
Atthesametime,Iwasexpresslyhiredtobethefirm’sEuropeanalyst.GivenStratfor’srootsin“GreatPowergeopolitics,”myposition wastheequivalentofbeingtheadmiraloftheSwissNavy.Mostofthe all-handsmeetingswereaboutTomahawks,carbombs,and jihad.IusuallygottofightwiththeAfricaanalystforthescrapsleftoverbythe MiddleEast,counterterrorism,andEastAsiaanalysts.
“But … theLisbonTreaty … ”IcouldfeelthesneersbeforeIfinishedmysentences–sneersfromthe“realanalysts”whosubsidizedmy EU-watching.
Thankfullyformycareer–andsadlyfor400millionEuropean citizens–theEuroAreacrisishitwithavengeance.Eventhough Icouldn’tnavigatemycreditcardstatementeither,Iknewthatthiswas mymomenttoaddvalue.
Thatsaid,allthiswasnotclearonthemorningofMay31,2010.I wasusheredintotheconferenceroombythesalespersonwhohandled thefirm’sfinancialrelationships.Itangentiallyknewwhattheseclients didforaliving.Mostwerepassiveintheiruseofthefirm’sservices.They readtheanalyseswepostedonline.Theygavelittlefeedback.Mostof thetimeIdidn’tknowifanyonecaredwhatIwaswriting.Butover thecourseofthenext12months,Iwouldhavethemostprofessionallyintenseperiodofmylife.Irealized alot ofpeoplewho definitely understoodhowinterestratesworkedwerereadingmyresearch.
“TheGermanpresidentjustresigned.Wearesellingeverything. Thisisit.”
IlookatthePolycom.Ihaveachoicetomake.DoIwafflemyway outoftheconversation,ordoIbitethebullet?
Somethingabouttheaccentontheotherendofthelineinstillsfear. IthinkitisaLongIslandaccent.Icannottellprecisely,asI’maSerb livingmyfourthyearintheUS.Beforearriving,allIreallyunderstood aboutAmericacamefrommoviesand TheSimpsons.Myguttellsme nottowaffle“LongIsland”; hewillknow.So,Itakeadeepbreathand ‘fessup.
“Guys,Idon’tknowwhotheGermanpresidentis.”
Silence.Uncomfortablylong.Iglanceatmycolleague;sheisrevising herrésuméinrealtime.Iimaginemybossdecapitatingmeonthesame boardroomtableatthenextall-handsmeeting.
“Whatdoyoumean?Aren’tyoutheEuropeguyatthisshop?!”
Ok,herewego.LongIslandisangry.Themanpaysforaserviceand isnotgettingit.Irespectthat.ButtheSerbinmenowstartstocome out.Igetirrationallyconfidentfornogoodreason.
“No … sorry,Iapologize.Youmisunderstoodme … yes,Iam the Europeguy.Andif I don’tknowwhotheGermanpresidentis … ” Silenceontheotherline … timetogoontheoffensive.
“ … Thenitisnotasignificantpieceofnews.ThepresidentofGermanyistheequivalentofQueenElizabeth;hecutsribbons,kisses babies,andshakeshandsattheairport.Idon’tknowwhyheresigned, butthiseventhaszerorelevance.”1
Thiswasariskymove.Theresignation could havebeenrelatedto theEuroAreacrisis.
1 GermanPresidentHorstKöhlerresignedbecause,in2010,itwasstillnotacceptablefora GermanstatesmantosaythatBerlinwoulduseitsmilitarytoprotectitseconomic interests–suchastokeeptraderoutesopen.Hewaswidelyrespectedandapopular, nonpoliticalleader.Ironically,hissuccessor(whoalsoresigned)latersaidmuchthesame thingwithlittlefanfareandnopressuretoresign,showinghowquicklytheworldwas evolvingintheearlypartofthe2010s.
TheconventionalviewatthetimewasthatGermanywouldnotbail outtheEUmemberstates.Germanswereobsessedwithfiscalausterity, risksofinflation,andthat“theSwabianhousewifesavedevery pfennig.”Maybethepresidentwasa“hard-money”zealotwhoobjectedto bailingoutprofligateEuroAreapeerslikeGreece.Maybehethought thatthecrisiswasanopportunityto“liquidateeverything”–inthe wordsofformerUSTreasurySecretaryAndrewMellon,whoalmost single-handedlyturnedasevererecessionintotheGreatDepression.
Andyet … Ihadareasonfordismissingthisnews.Ihada framework, andithadtaughtmetopushhardagainsttheEuroscepticnarrativefor months.ThisviewonEuropewouldbecomeasuccessfulinvestment theme,andtheprotoframeworkthatIhaddevelopedwouldbecome myprofessionandpassionovertheensuingdecade.
Thisframework–whichfocusesonthematerialconstraintspolicymakersface–iswhatthisbookisabout.
Theframeworkboilsdowntothis:NiccolòMachiavelliwaswrong. Noamountof Virtù willhelpthePrinceovercome Fortuna.Sodon’t studythePrince.Studyhisconstraints.
Backin2010,Itakeagamblebecause“LongIsland”pushedmy buttons.Itisaneducatedgamble.LongIsland’ssingularfocusonrelevance–the“sowhat?”–forcesmetomakeacall.Nottowaffle, nottotalkabout“ontheonehand”and“ontheotherhand,”not tosplithairsabout“hard-to-estimateprobabilities,”buttogivehiman investment-relevantviewinthreesentences. TheresignationoftheGerman presidentdoesnotmatter.Gobacktomakingmoney.
“Oh … gotit.Thankyou.We’lltalklater.”
Click. Exhale.
Istraightenupandturntomycolleague,chestflexed,a“What’s up?”lookonmyfacewhilemaintaininganairof“Ihadthistheentire time.”(Ididnot.)
Inaslow,staccatovoice,shesays,“Theseguysdon’tknowwhatthey aredoing.”
Boom.Thereitis.MyJerryMaguiremoment.Ifwewereinacartoon,alightbulbwouldhavepulsatedabovemyheadandburst.Ireply:
“They’renotstupid.Thatguycouldliterally buyme totutor hiskidsfortherestofmylife.Theseguysarenotstupid.Theyare just … busy.”
Andhuman.Andover-professionalized.Tobecomeaninvestment professionalin2010,onehadtobeconfidentinalotofsubjects,but abasicgroundinginpoliticalsciencewasnotamongthem.Thisfailing isnotbecauseinvestorssuddenlybecameignorantofglobalaffairsand historybutbecausethoseskillsetshadnotmatteredformostinvestors sinceatleast1985.2
Thatmomentledtoacareer-alteringdecisionforme.Idecidedthat Iwantedtodeviseaframeworkforgeopoliticalforecastingrootedinthe realworld.Notbasedonconversationswith“wisemeninsmoke-filled rooms”oronanarrow,inflexibleviewthatgeographyandhistorypredetermineoutcomes,butonactualresearchandfundamentals.Aframeworkthatwasnotonlyeasytousebutthatwasreplicablebyotherswho soughtinsightsintothefuture.
ThereweretworeasonsIfeltconfidenttodeclarethattheresignation oftheGermanpresidentwasirrelevant,bothrootedinmaterialconstraints.First,thepresidentwasconstrainedbyGermany’sconstitutional irrelevance.Second,IalreadyhadaframeworkforwhatGermanpolicymakersandvoterswouldbeforcedtoacceptintheEuroAreacrisis. EvenifIhadbeenwrongaboutthisparticularnewsitem,Ihadastructural,macroviewofwhatwouldhappennextintheEuroAreacrisis,one thatwasunlikelytounravelduetoasingleresignation.AsIexplainin
2 Mostdoesnotmeanallinvestors.Manyofthegreatestmacrohedgefundmindsofthe pastthreedecadesmadesmartcallsbasedoncorrectgeopoliticalinsights.Forexample, GeorgeSoros“broke”theBankofEnglandin1992byunderstandingthattheBundesbank mayburndeutschmarksdefendingtheliraandthepeseta,butnotthepound.Asidefrom theoccasionalstoryofanastutegeopoliticalinsightleadingtofameandfortune,most professionalinvestorshavenothadtocareaboutgeopoliticsintheirdailylivesforavery longtime.
Chapters4and5,theEuroAreacrisisillustrateshowmaterialconstraints impactnotonlypolicymakersbutalsovoters.Europeanintegrationis notonlygoingtocontinue,itwillaccelerateoverthenextdecadedue totheseepochalconstraints.
Afterdownloadingtheconstraint-basedframework,thereaderwill beabletostoprelyingonthenewsflowforanalysis.Muchasananchor keepsashipfrombeingblownouttosea,constraintsanchorthesmart investortoasubjectiveprobabilitygroundedinmaterialreality.
Itakeonechaptertodescribethisframework.Thepunchline: investors(andanyoneinterestedinforecastingpolitics)shouldfocuson materialconstraints,notpolicymakerpreferences.
Preferencesareoptionalandsubjecttoconstraints,whereasconstraints areneitheroptionalnorsubjecttopreferences.
Theeraofgeopoliticalignoranceisover.Thedayswheninvestors andcorporatedecision-makerscouldbesuccessfulwithoutmuchunderstandingofpoliticswillbeafootnoteintheannalsofhistory.Inthefirst chapter,Igoovertheseparadigmshiftsratherquicklybecause,atthetime ofthiswriting,theideathat“we’renotinKansasanymore”isobvious.
Atthesametime,noteveryoneneedstorushtoenrollinpolitical sciencecourses.Theconstraintframeworkhasworkedwellformeby providingthetoolssufficienttomakesenseofpolitics.Assuch,Ihope toofferprofessionalswhomusttakepoliticsseriouslyashortcut–nota foolproof,scientificmethod–toforecastinggeopolitics.
Thefocusoftherestofthebookisontheframeworkitself.While Iinitiallybuilttheconstraintframeworktohelpinvestorsmakesenseof geopolitics–andmakemoneyintheprocess–theC-suitecanalsouse ittomakelong-terminvestmentdecisions.Journalistscanuseittofind therightbuttonstopushinaninterview,andvoterstobecomemore politicallyinformed.3
Chapter2describestheinspirationfortheconstraint-basedframework.Itisamixofpoliticalscience,politicaltheory,intelligenceanalysis, andsocialpsychology–aswellasvoodooandtrialanderror.
Whyreadbeyondthefirstpartthatdescribestheframework?Itisone thingtoheartheframeworkdescribed;itisanothertoseeitinaction.
3 Bytheway,ifyouhave that relativeateveryfamilygathering,thisisaperfectbooktoget themfortheholidays!
Itwouldbeliketellingabuddingskierthatskiingcomesdowntobalance andreadingtheterrain.Soundsawesome.Nowplungeyourselfdowna doubleblackslope.Ithereforetaketheframeworkforaspin,usingrecent geopoliticalandpoliticaleventsastheracetrack.Thebookconcludes byoperationalizingtheframeworkinaprocessthatgivesusthetitle: GeopoliticalAlpha.Alpha,inthecontextofthisbook,referstoareturn onaninvestmentagainstabenchmark,infinance-speak,ratherthanthe leaderofapackorsomeonespendingtoomuchtimeinagym.
Therearethreethingsthisbookdoes not aimtodo.
First,itcannotteachyouabouttheworld.Towieldtheconstraintbasedframeworkcompetently,youmustknowalot.Forinstance,that theGermanpresident = QueenElizabeth.Ifyoudon’tknow,speakto experts.ThatpotentialabsenceofaknowledgebaseiswhyIincludea chapteronhowtouseexpertjudgment.
Second,thisbookwillnottellyouthefuture.Thisisamethods book.Iofferupmyframeworkbecausemanyinvestmentprofessionals havefoundituseful.ButIamnotaprophet,norwillfocusingonconstraintsmakeanyoneelseaprophet.Thisbookissimplymyattemptto sharewhathasworkedforme.Thereareotherframeworksoutthere thatworkforotherinvestmentstrategists.
Third,thisbookwillnottellyouwhatIthink should happen. Idon’tcare.Notinthisbook,notinmyfield.Iamaprofessional nihilist.Andifyouanalyzepoliticsforaliving–especiallyifyouhavea fiduciarydutytoyourinvestors–youshouldbethesame!Tocompetentlyusemyframework,meditateonyourbiasesandbatheyourselfin indifference.Ifyouarenotuptoit,youshouldnotbeintheforecasting business,letalonefinance.
PartOne SCAFFOLDING Chapter1 We’reNotinKansasAnymore Theworldisundergoingparadigmshiftsonmultiplefronts:political, geopolitical,generational,andtechnological.Whatthesechanges areandtheirimplicationsforthefuturearebeyondthescopeofthis book.Instead,Ipresentaframeworkthathashelpedmemakesenseof theworldoverthepastdecade.Ihopeitwillprovehelpfultonavigate theparadigmshiftstocome.
Iusetheterm“framework”becauseitislessdeterministicthana theoryandnotasprescriptiveasamethod.Itismessy,fullofcontradictions,andmuchmoreartthanscience.Itfitswithforecastinggeopolitics andpoliticsbecauseforecastingissimilarlymessy.ThereisnothingparsimoniousabouttheconstraintframeworkIpresent.
Inthepast25years,geopoliticsandpoliticshaveswitchedfrombeing tailwindstotheglobaleconomyandmarketstobeingheadwinds.For manyinbusinessandfinance,itfeelslikearughasbeenpulledoutfrom underthem.Iknowthefeeling;Isawithappentomyfamilyfirsthand whenIwaseightyearsold.
CutofffromtheYellowBrickRoad In1986,my36-year-olddadjoinedGeneralExport(Genex),the crèmede lacrème ofYugoslavia’scorporateworld.Formydad,itwastheequivalent oflandingajobatIBMinthe1950s-eraUnitedStates.
Dadhad made it.Hislife–andbyextensionmylife–wasgoing tobepure kajmak. 1 Stepone:afour-yearstintintheLondonoffice (“soyouandyoursistercanlearnEnglish”).Stepstwoandbeyond:an upgradetoour505-square-foot“condo,”thenmaybeacarwithmore thantwocylinders,ahouseontheDalmatiancoast,ayearataforeignuniversity … culminatinginanentréeintotheupperechelonsof socialistsociety.2
WhatwassogreataboutGenex?Attheendof1989,theconglomeratecontrolled12–13%ofYugoslavforeigntradeandnearlyathirdof Serbiantradewiththerestoftheworld.3
Whatdiditmanufacture?Whatservicesdiditexport? Nothingandnone.WhatGenex“manufactured”waspuregeopolitical alpha.
TheSovietsdidnotbelieveinrunningatradedeficit.So,every year,theUSSRwouldproducealistofgoodsthatitwasinterestedin exchangingforbarter.BecauseYugoslaviawasapromiscuouscommunist country–itplayedbothsidesoftheColdWar–acompanylikeGenex wouldsellYugoslavandforeigngoodstotheSovietsinexchangefor whattheUSSRwaswillingtoexport(mainlycommodities).Genex wouldthenselltheSovietcommoditiesintheglobalmarket,pocketing aheftyprofitinhardcurrency.
UnfortunatelyforGenex,butfortunatelyforalmosteveryoneelse ontheplanet,theBerlinWallfellonNovember9,1989.Twoyearslater, theSovietUniondisintegrated.Thegeopoliticalgravytrainendedand Genex’sedgewithit.Thefirm’sentirecorporatestrategywasleveraged tothegeopoliticalstatusquo.Infact,myhomelandwasbasicallyliving offtheColdWar.Whenthegeopoliticalwindsshifted,theendwasnigh forbothGenexandYugoslavia.
1 Like“gravy,”butcheese and much worseforyourcardiovascularsystem,ifyoucan believeit.
2 Fromwhichthereisnoslidingbackintotheproletariat!
3 “RiseandFallofGenex:ToHaveandNottoHave,” TransitionsOnline,April25,1998.
Thankstothecombinationofamassivegeopoliticalparadigmshift andepicmismanagement,Yugoslaviainthe1990swasworthyofa chapterinJaredDiamond’s Collapse.Thenear-first-worldlifethatmy familybuiltinBelgradedescendedintohellinweeks.
Thecountry’scurrency,thedinar,wasdevalued18timesinseven years,with22zeroserasedfromitsvalue.4 Themonthlyrateofinflation peakedat313,000,000%inJanuary1994–atthetimethesecond-highest recordedrateofinflation.5 BetweenFebruary1992andJanuary1994, thepricelevelinYugoslaviarosebyafactorof3.6 × 1022 6 Ihavean academicfootnotetoproveit.7
MyhometownofBelgradecamefourthinthe1986voteforthe 1992SummerOlympics.Butby1992,ithaddescendedintoanepisode of TheWalkingDead.InMay1994,myfamilyleftBelgradewithtwo suitcases.Destination?Amman,Jordan.8
Thankfully,mydadsawitcoming,sohequitGenexafewyears beforethedeluge.Hegotajobinadirectsalescompanysellingcooking pots.HewentfromfauxIBMtoessentiallyTupperware.
Manyyearslater,wheneverIfrettedaboutmygradesorschoolin general,hetoldme,“Relax.Whyareyoustressed?Doyouknowwhat MarxandEngelshavetosayaboutdirectsales?Nothing.AllmyuniversityexamsandworkexperienceareuselessforthedamnjobIdotoday.”
IfyouareaCIOofaninstitutionalinvestmentfund,aportfoliomanagerinanassetmanagementfirm,oraC-suitexecutive,youalsoface geopoliticalparadigmshiftsthatwill,atbest,makeyourworkmorechallenging.Atworst,theywillcollapseyourcivilizationliketheycollapsed myfather’s.Inthisbook,myintentionistoofferyouaframeworkwith whichtoprepareyourselffortheformerpossibility.Forthelatter,I’ve gotnothing.
4 SteveH.Hanke,“TheWorld’sGreatestUnreportedHyperinflation,” CatoInstitute,May 7,2007,https://www.cato.org/publications/commentary/worlds-greatest-unreportedhyperinflation.
5 OnlybehindtheHungarianrecordfrom1945–1946,until–tomysomewhatperverted disappointment–Zimbabwebeatoutbothcountriesin2008.
6 Whatdoesthateven mean!?
7 PavlePetrovi ´ c,etal.,“TheYugoslavHyperinflationof1992–1994:Causes,Dynamics, andMoneySupplyProcess,” JournalofComparativeEconomics,July31,2013.
8 Yes,youreadthatright.Weranawayfromwarbygoing to theMiddleEast.
Investorsareallinthesamepredicamentthatmydadfacedatage36. Thetraining,certifications,andexperienceofthepast35yearshave woefullyunderpreparedtheWest’sfinancialandcorporatecommunities fortheparadigmshiftsthatareoccurring.
TheEndoftheGoldilocksEra Politicsandgeopoliticshaveshapedinvestmentandbusinessdecisionsfor centuries.Inhisseminalwork, TheHouseofRothschild,NiallFerguson describeshowtheRothschildfamily–well-versedingeopoliticalanalysis–becametherichestandmostpowerfulfamilyofthenineteenth century.AdamSmithnamedthebibleofeconomics AnInquiryintothe NatureandCausesoftheWealthofNations.Notpeople,notcompanies, norcorporations,but nations.AndwhileJohnMaynardKeynesismost renownedfor TheGeneralTheoryofEmployment,InterestandMoney,he showedtherangeofhisgeniusin TheEconomicConsequencesofthePeace (1919),wherehecorrectlyforecastedtheriseofthepopulistright,the SecondWorldWar,andeventheEuropeanUnion.9
Forcenturies,successinbusinessandinvestingrequiredtheskillsof bothlongdivisionandsensitivitytopoliticalandgeopoliticalchange.Yet todaythecurriculaofmostMBAprograms– and theCFAcurriculum inits entirety –ignorethelatter.
Forthebetterpartofaquarter-century,between1985and2008, electionresultsinmostlargemarketsmadelittledifferencetothepriceof assetsorcompanyearnings.10 Forthevastmajorityofinvestors,politics andgeopoliticswereworthyofaone-hourmeetingatthestartofthe yearor,atmost,asmallexpenseontheresearch/consultingbudget.
Politicsandgeopoliticsstillplayedarole,butinthebackground, workingasatailwindinthesailsofinvestors.Eventsandparadigm shiftsplayedoutintothehandsofthemultinationalcorporateand
9 JohnMaynardKeynes, TheEconomicConsequencesofthePeace (NewYork:Harcourt, Brace,andCompany,1922).
10 Iwouldarguethatthelastelectionofanyrelevancetothefinancialmarketsinamajor developedmarketeconomyinthe1980–2010stretchwasthe1981Frenchelection,in whichsocialistFrançoisMitterrandwonanupsetoverthecenter-rightValéryGiscard d’Estaing.Iamopentoadebateonthisquestion.
financialcommunities.Asaresult,anewcropofinvestorsemergedout ofthisGoldilocksErawhowereoverquantified,whilethegray-hairs andtheircautionarytalesrecededintoneglect.
SincethecollapseoftheSovietUnion,Americanhegemonymeant thatwarseitheroccurredininvestment-irrelevantcountries–Rwanda, Armenia,Azerbaijan,Moldova,Somalia,BosniaandHerzegovina, Lebanon,etc.–orwerefinishedquickly,suchastheFirstGulfWarorthe 1999NorthAtlanticTreatyOrganization(NATO)airwaragainstSerbia.
BythetimeIenteredthefinancialindustryin2011,fewifanyofmy clientsandcolleagueshadeverhadtomakeaninvestmentdecisionbased ongeopolitics.Theworld’spremierpoliticalriskconsultancy–Eurasia Group–announcedinitsverynamethatitsfocuswasonthefringesof thecorporateworld.By“Eurasia,”IanBremmer–thefirm’sfounder andavisionaryinthefieldofpoliticalriskanalysis–meantthefrontiermarketsoftheformerSovietUnion.In1998,Bremmer’svision wasthatpoliticalriskanalysiswouldmatterfor“theStans”andfew others.
Why? TheanswerliesinMikhailGorbachev’s1985“Leningradspeech”–theonewherehelambastedtheSovietleadershipandlaunched perestroika (“restructuring”).11
Bythelate1970s,theSovietUnionwasinthemidstofadeep economicmalaise.Livingstandardshadstoppedimprovingthroughout thedecade,andtheSovietUnionfellfarbehindtheUSintermsof technologicaladvancement.Gorbachevthrewintheproverbialtowelin thecontestbetweenastatist-plannedeconomyandafree-marketone.
ByconcedingthedefeatofcommunismintheSovietUnion,Gorbachevundermineditintherestoftheworld.Theconsequenceofthis ideologicalcapitulationwastheThirdWaveofdemocratizationandthe adoptionoffree-marketpoliciesacrosstheglobe.Withinadecadeof Gorbachev’sspeechinLeningrad,free-marketcapitalismbecame“the onlygameintown,”andwithintwodecades,90%oftheglobalpopulationwaslivingincapitalism(Figure1.1).
11 BruceSteinberg,“ReformingtheSovietEconomy,” Fortune,November25,1985, https://archive.fortune.com/magazines/fortune/fortune_archive/1985/11/25/66654/ index.htm.
Gorbachev admits that the “jig is up” American unipolar moment
SMOOTHED.
Figure1.1 Perestroika launchedthelargestsupply-siderevolution.
ThestrategicvictoryoftheUSovertheSovietUnioncomplementedtheideologicalvictoryofthefreemarket.Withthedissolution oftheSovietUnion,theUSbecamethesolesuperpowercapableof enforcingnormsofstatebehavioronaglobalscale.
TheUSdidsobychallengingrevanchistregimesthatwerewillingto challengethenewstatusquo,suchasSaddamHussein’sIraqandSlobodanMiloševi ´ c’sYugoslavia/Serbia.12 Italsosupportedthenewcapitalist orthodoxybyencouraginginternationaleconomicinstitutionstopromotemacroeconomicreforms,dubbedthe“WashingtonConsensus.”
Thedefeatofdemand-sidepoliciesintheThatcher–Reaganrevolutionofthe1980soccurredalongsidetheSovietdefeat.Profligatefiscal policy,politicizedmonetarypolicy,andaninflexibleregulatoryregime hadsaddleddevelopedmarketsthroughoutthe1960sand1970s,culminatingindramaticinflationthatwasonlyexacerbatedbythe“oilshock” followingthe1973YomKippurWar.13
12 Asachild,Ihadthe“pleasure”oflivingunderbothregimes!
13 Apopularmisconceptionisthatthe1973oilshockcausedthestagflationaryenvironment ofthe1970s.Thisisnottrue.Commoditypricesex-oilwerealreadyontherisewell beforetheYomKippurWar,signifyingthatinflationwascomingonewayoranother.
Inresponsetothiseconomicmalaise,UKPrimeMinisterMargaret Thatcherinstitutedherneoliberalshocktherapy.Whiletheinitial outcomewasarecessionandelevatedunemployment,herpolicies eventuallyledtoaneconomicrecoveryinthelate1980s.Thatcher’s taxcuts,privatization,andderegulationbecamethepillarsthatwould underpintheWashingtonConsensus–and laissez-faire economicsin general–thatcountrieswouldreplicateacrossthedevelopedandlater thedevelopingworld.
Onecountrythatrejectedthesupply-siderevolutionwasFrance. In1981,inthemidstoftherightwardpolicyturnintheUKandthe US,FranceelectedsocialistFrançoisMitterrand.Mitterrandranonan unabashedlyleft-wingpolicypackagecalledthe“110Propositionsfor France.”Thepackageofreformsincludedpricecontrols,reregulationof industries,minimum-wageincreases,publicworksprograms,amassive public-sectorjobprogram,nationalizationofmajorindustrialgroups, reductionoftheworkingtime,awealthtax,andanextensionoftrade unionpowers.Mitterrand’ssurpriseelectoralwinledtotwomajorruns onthefrancintheyearafterhisvictoryandtheresultingnearignominy ofcontemplatingaidfromtheInternationalMonetaryFund(IMF).
Inthebattleofideas,theThatcher/Reagansupply-side– laissezfaire –wonasdecisiveavictoryoverMitterrand’sdemand-side–dirigisme –asonecouldimagine.Votersandpolicymakersacrossthe developedworldtooknoteandadjustedbehavioraccordingly.14
Bythemid-1980s,thetwintailwindsof laissez-faire economicsand AmericangeopoliticalhegemonycreatedtheultimateGoldilocksscenarioforinvestorsandC-suiteexecutivesalike.
Onthegeopoliticalfront,hegemonicstability–inthewordsof CharlesKindleberger–prevailed.15 TheGeorgeH.W.BushandBill
14 Thevictoryofsupply-sidepoliciesintheearly1980soverdemand-sidewasnotabsolute butrathercontextual.Withrunawayinflationcausedbyexcessivefiscalandmonetary stimulusinthe1960sand1970s,aswellascapacityconstraintsbuiltupthrough over-regulation,supply-sidesolutionswerethecorrectsuiteofpolicies fortheera. Thisdoesnotmeanthataddingmoresupplyisalwaysthecorrectsolution.Policymakers havelearnedthisthehardwayintoday’ssecularstagnationera,wherearguablyitisnot supply,butratherdemand,thatislacking.
15 CharlesKindleberger, TheWorldinDepression (Berkeley:UniversityofCaliforniaPress, 1975).
Clintonadministrationsenforcedthatstabilitywhentheyengagedwith therestoftheworld.16 TheUSforeignpolicyestablishment,staffed mainlybyforeignpolicyhawkswhocuttheirteethontheColdWar, favoredanactivistandengagedforeignpolicy,onethatensuredtheUS wouldcontinuetoprovidetheexpensiveglobalpublicgoodsnecessary togreasethewheelsofeconomicglobalization.
TheTornadoHitsKansas:GeopoliticalParadigmShifts Hegemonysowstheseedsforitsowndecline.America’spolicingfreed upothercountriestostrengthentheirowneconomicindependence.By usheringinstabilityandglobalization,theUSallowedcountriestoset asidetheirchallengestoUShegemonyandfocusoneconomicdevelopment.Butthosematerialgainsultimatelyallowedthesechallengersto gettothepointwheretheycouldchallengetheUSforhegemony.This isthestoryoftheriseandfallofempires;stabilitybreedscollapse.17
InthewakeoftheGreatRecession,amessy,multipolarworldhas replacedAmericanhegemony.
Multipolarityisaconceptfrompoliticalsciencethatdescribesa worldinwhichnosingleentity(unipolarity)–andnotwoentities (bipolarity)–possessapreponderanceofpowerwithwhichtoimpose orderinanotherwiseanarchicsystem.Instead,multiplecountriespursuetheirnationalinterestsindependently,anarrangementthatforecasters know–fromhistoryandpoliticalsciencetheory–produceshighgeopoliticalvolatility(Figure1.2).18
16 Tothisend,thedecisionbyBushSr.tointerveneinSomaliaattheendofhistermwas anattempttobindtheincomingClintonadministration–seenasisolationistanddomesticallyfocused–toaninternationalistforeignpolicy.AdebatewasraginginWashington amongpolicymakersandacademicsoverwhethertheUSshouldremainengaged.Many ColdWarwarriorsworriedthattheUSmayabandonaleadershiproleasitdidafterits previousunipolarmoment:inthe1920swhenitdecidedtoturnitsbackontheLeagueof Nations.Thisprovedtobeamisplacedfear,asClinton’seightyearsinpowerdefinitely reinforcedAmerica’shegemonicrole.
17 RobertGilpin, WarandChangeinWorldPolitics (Cambridge:CambridgeUniversity Press,1995).
18 JohnMearsheimer, TheTragedyofGreatPowerPolitics (NewYork:W.W.Norton& Company,Inc.,2001).
