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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
Forecast geopolitics and markets with this clear and insightful resource
Geopolitical Alpha – An Investment Framework for Predicting the Future provides readers with an original and compelling approach to forecasting the future and beating the markets while doing so. Persuasively written by author, investment strategist, and geopolitical analyst Marko Papic, the book applies a novel framework for making sense of the cacophony of geopolitical risks with the eye towards generating investment-relevant insights.
Geopolitical Alpha posits that investors should ignore the media-hyped narratives, insights from "smoke-filled rooms," and most of their political consultants and, instead, focus exclusively on the measurable, material constraints facing policymakers. In the tug-of-war between policymaker preferences and their constraints, the latter always win out in the end. Papic uses a wealth of examples from the past decade to illustrate how one can use his constraint-framework to generate Geopolitical Alpha. In the process, the book discusses:
- What paradigm shifts will drive investment returns over the next decade
- Why investment and corporate professionals can no longer treat geopolitics as an exogenous risk
- How to ignore the media and focus on what drives market narratives that generate returns
Perfect for investors, C-suite executives, and investment professionals, Geopolitical Alpha belongs on the shelf of anyone interested in the intersection of geopolitics, economics, and finance.
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Veröffentlichungsjahr: 2020
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Table of Contents
Cover
Foreword
Introduction
Notes
Part One: SCAFFOLDING
Chapter 1: We're Not in Kansas Anymore
Cut off from the Yellow Brick Road
The End of the Goldilocks Era
The Tornado Hits Kansas: Geopolitical Paradigm Shifts
The Nail in the Coffin: COVID-19
Welcome to Oz
Beware of the Wizards
Notes
Chapter 2: The Constraint Framework: Three Pillars
Geopolitics Is Not a “Nice-to-have”
The First Pillar: Materialist Dialectic
Second Pillar: Diagnosticity of Constraints
Diagnosticity in Practice
Third Pillar: The Person versus the Situation
Fundamental Attribution Error in Practice
The Three Pillars of the Constraint Framework
And Now for Some Math
Where Do We Go from Here?
Notes
Chapter 3: The Wizards of Oz
Overview: Intelligence and Investing
The False Expert
The Connected Player
The Funnel
The Insider
The Spy
You Cannot Outsource Your Fiduciary Duty
Notes
Part Two: THE CONSTRAINTS
Chapter 4: Politics
“You May Have All the Money, Raymond …”
… But Boris Has All the Rhetoric
Introducing the Median Voter Theorem
Predicting the Long-term: Welcome to the Buenos Aires Consensus!
MVT in a Vote-less Nation: Does China Have a Median Voter?
Political Constraints: Takeaway
Notes
Chapter 5: The Economy and the Market
Between a Rock and a Hard Place
Fundamentals at Work: The German Question
Greece After the Euro: The Land of Milk and Honey?
Geopolitics versus Economics: Is Trade War Sustainable?
Power Dynamics and Ancient Greece: A Theory Interlude
Relative Gain: Why Trade Wars Fizzle in a Multipolar World
The World Wars: Economic Constraints in a Multipolar World
Economic and Market Constraints: Takeaway
Notes
Chapter 6: Geopolitics
Origins of Geopolitical Theory
The Trump Doctrine
Russia's Constraints Abroad
Geopolitics: The Takeaway
Notes
Chapter 7: Constitutional and Legal Constraints: The Constraint–Preference Hybrids
Euro Area Crisis Averted
Trump and Trade
Reconciliation and the Markets
The US Budget Process
The Reconciliation Process
Reconciliation and the 2017 Tax Reform: So What?
How to Peddle a Budget-busting Tax Cut
Constitutional and Legal Constraints: The Takeaway
Notes
Chapter 8: The Time Constraint: When Preferences Run Down the Clock
Material Constraints Versus Terrorism
Material Constraints Versus COVID-19
Non-linearity and COVID-19
Gargantuan Stimulus: Nuthin' But a G Thang
Time is the Achilles' Heel of the Constraint Method
Notes
Part Three: OPERATIONALIZATION
Chapter 9: The Art of the Net Assessment
Three Lenses of Geopolitical Forecasting
Net Assessment: The Bayesian Prior
India Net Assessment: An Investment Thesis Built on Mean Reversion
What Is Keeping India from Mean Reverting?
Underinvested: India's Fulcrum Constraint
Why Is Investment the Fulcrum Constraint?
India Net Assessment: Investment Implications
War in the Middle East: Net Assessment
Net Assessment: The Takeaway
Notes
Chapter 10: Game Theory – It's Not a Game!
Before You Play the Game, Set the Gameboard
Beware Simplistic Games
Game Theory: The Takeaway
Notes
Chapter 11: Geopolitical Alpha
Chocolate Labrador Brian Versus Marine Le Pen
“So, You Want to Go Long Socialism and Short Capitalism”
Geopolitical
Alpha
: The Takeaway
Notes
Chapter 12: Conclusion
Note
Acknowledgements
Note
Bibliography
Index
End User License Agreement
List of Illustrations
Chapter 1
Figure 1.1
Perestroika
launched the largest supply-side revolution.
Figure 1.2 Multipolarity begets disequilibrium.
Figure 1.3 Developed world middle classes stagnated amid globalization.
Chapter 2
Figure 2.1 If something blows up, just close your eyes and buy.
Figure 2.2 Middle-class goods inflation.
Figure 2.3 What is unsustainable will stop.
Figure 2.4 Popular support for Obamacare became a material constraint.
Chapter 3
Figure 3.1 No-deal Brexit hysteria.
Figure 3.2 The real reason for Johnson's bravado.
Figure 3.3 Argentina – promise vs. performance.
Figure 3.4 Misery index doesn't lie.
Figure 3.5 Republican presidents expand budget deficits.
Figure 3.6 Voters welcome Republican profligacy.
Figure 3.7 The Tea Party allowed this to happen.
Chapter 4
Figure 4.1 The J curve of structural reform.
Figure 4.2 President Putin's political capital surged after Crimean annexati...
Figure 4.3 “Bregret” was a constraint.
Figure 4.4 Median voter theorem in action.
Figure 4.5 The US is an outlier in measures of inequality and social mobilit...
Figure 4.6 The US is an outlier in measures of the middle class.
Figure 4.7 The coming Buenos Aires Consensus.
Figure 4.8 The dreaded middle-income trap.
Figure 4.9 China is at a critical middle-class threshold.
Figure 4.10 Chinese coastal provinces are already ripe for democracy.
Figure 4.11 Wealth supports effective democracy.
Chapter 5
Figure 5.1 The market asleep.
Figure 5.2 Germany diluted the deutschmark.
Figure 5.3 Germany got ready for the Euro Area.
Figure 5.4 Germany needs Europe.
Figure 5.5 German support for the Euro Area is strong.
Figure 5.6 Silly Greeks, disagreeing with eminent economists.
Figure 5.7 Why leave when the hard work is done?
Figure 5.8 A herculean fiscal adjustment.
Figure 5.9 Trade war in a bipolar world.
Figure 5.10 Trade war in a multipolar world.
Figure 5.11 The Allies traded with Germany …
Figure 5.12 … Right up to World War I.
Figure 5.13 Japan and the US kept trading right up to the war.
Figure 5.14 Never assume red lines when Euro Area death is on the line.
Chapter 6
Figure 6.1 Ukraine: Europe's Argentina?
Figure 6.2 Germany has Russia by the pipelines.
Chapter 7
Figure 7.1 The US budget process: a fantasy time line.
Chapter 8
Figure 8.1 COVID-19 is ageist.
Figure 8.2 Hospitalization and fatality rates.
Figure 8.3 Revenue is going to zero.
Figure 8.4 Mortality rate increase in Greece.
Figure 8.5 Is the CDC manipulating data?
Figure 8.6 Disconnect between deaths and cases goes global
Figure 8.7 Sweden: the petri dish for COVID-19
Figure 8.8 Elderly: not stupid
Figure 8.9 Opening the economy is leading to new infections
Figure 8.10 A Robust Recovery Is Afoot
Figure 8.11 An
I
-Neck Recovery
Figure 8.12 The Buenos Aires Consensus
Chapter 9
Figure 9.1 The Bayesian process.
Figure 9.2 India's investment thesis is built on mean reversion.
Figure 9.3 Why the dropoff in investment amid a reformist government?
Figure 9.4 India has a lot of catching up to do.
Figure 9.5 India needs to raise more taxes.
Figure 9.6 India: a sneaky-great place to be rich?
Figure 9.7 India – a very poor country – is more unequal than America.
Figure 9.8 One of these things is not like the others.
Figure 9.9 Exports have stagnated while manufacturing is collapsing.
Figure 9.10 India needs new labor laws.
Figure 9.11 Strong productivity performance has stalled.
Figure 9.12 The West is souring on trade.
Figure 9.13 Shocking performance of rural wages.
Figure 9.14 The JCPOA allowed the US to deleverage.
Figure 9.15 Americans do not want a war with Iran.
Figure 9.16 Iran–US conflict decision tree (May 2018).
Chapter 10
Figure 10.1 The US is less leveraged to trade …
Figure 10.2 … and clearly the customer.
Figure 10.3 Two-level game.
Figure 10.4 Competing tolerance curves show only part of the gameboard.
Figure 10.5 Regular game of chicken.
Figure 10.6 2015 Greek crisis game of chicken.
Chapter 11
Figure 11.1 Ready my chart: the migration crisis is over.
Figure 11.2 The euro was Le Pen's foil.
Figure 11.3 Structural reforms are coming to France.
Figure 11.4 This chart is insane …
Figure 11.5 … given this chart!!
Figure 11.6 Industrials: buy France/short Germany.
Figure 11.7 Mexico has positive carry vs. Brazil.
Chapter 12
Figure 12.1 Constraints to flatten-the-curve narrative will grow.
Guide
Cover
Table of Contents
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GEOPOLITICAL ALPHA
An Investment Framework for Predicting the Future
ByMarko Papic
Copyright © 2021 by Marko Papic. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750–8400, fax (978) 646–8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748–6011, fax (201) 748–6008, or online at www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762–2974, outside the United States at (317) 572–3993, or fax (317) 572–4002.
Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.
Library of Congress Cataloging-in-Publication Data:
Names: Papic, Marko (Geopolitical strategist), author.
Title: Geopolitical alpha : an investment framework for predicting the future / by Marko Papic.
Description: Hoboken, New Jersey : John Wiley & Sons, Inc., [2020] | Includes bibliographical references and index.
Identifiers: LCCN 2020025448 (print) | LCCN 2020025449 (ebook) | ISBN 9781119740216 (hardback) | ISBN 9781119740230 (adobe pdf) | ISBN 9781119740223 (epub)
Subjects: LCSH: Investment analysis. | Geopolitics—Economic aspects. | Economic forecasting. | Investments.
Classification: LCC HG4529 .P37 2020 (print) | LCC HG4529 (ebook) | DDC 332.67/253—dc23
LC record available at https://lccn.loc.gov/2020025448
LC ebook record available at https://lccn.loc.gov/2020025449
Cover Design and Illustration: Tata Wijana Warsita
Author Photo: © Steven Drobny
This book is dedicated to the country that no longer exists.
Pjevaj nek te čuju, ko ne sluša pjesmu slušaće oluju!
Foreword
Montreal. February 2017.
A cold, dark, and ice-stormy night.
I met Marko Papic for the first time over dinner at a spot he enthusiastically called “the coolest restaurant in town.” Upon entering, I found a dark and empty restaurant save for a bartender, a waiter, a mâitre d', and a lone customer sitting in the back corner. I started strategizing a polite early exit. But the food and drinks were incredible, and we proceeded to have an excellent, wide-ranging conversation. We stayed late and got totally blasted. It was the first of many times I would observe Marko make a correct, out-of-consensus call.
Within minutes of meeting Marko, I knew he was unique. My singular skill is sniffing out quality from crap and gathering the good ones around me – be it finding new money managers to run capital for our institutional clients, bringing together smart investors on a deal, backing founders of new financial technology companies, or convening the most interesting people in the world at an event in some far-flung location. I also seek out those with unique skills and try to persuade them to join the Clocktower Group team.
By the time I met Marko, I'd been looking for a chief strategist for a while. I needed someone to act like a basketball center, a big man in the middle to gel the team. I was looking for a beautiful mind to sit on top of our unique and exclusive information flow, then channel it into a coherent form for our clients. At first, I looked for the typical economist. Over the past 40 years, bond markets, central bankers, and finance ministers drove markets – and the world. It was the Lords of Finance and the Committees to Save the World who pulled the puppet strings, and the alpha lay in correctly forecasting their next move.
Enter 2016.
The passing of the Brexit referendum and the election of Donald Trump marked a sea change in the macro game. Populist movements in developed countries drove home the point that the era of the economist and the interest rate soothsayer was over. In the post-Trump, post-Brexit era, geopolitics are all that counts. With interest rates pegged to the zero lower bound for the foreseeable future, the Lords of Finance and Committees to Save the World have run out of ammo.
As such, Clocktower's chief strategist needed not be an Ivy-trained economist with a perfect résumé coupled with a PhD, CFA, MBA, and other meaningless acronyms. We needed someone not locked on the movements of the Fed & Co., but focused on international and domestic politics. The battles and power players of today (and tomorrow) are Trump versus Xi, the UK versus Europe, Putin versus world, MBS, Macri, Bolsanaro, etc.
Enter Marko Papic: a geopolitical expert who grew up getting chased by packs of wild dogs in collapsing Yugoslavia; who subsequently moved to Iraq, Jordan, Switzerland and Texas; and who married a Tejana and settled in Canada. Whispers of an unorthodox geopolitical thinker with out-of-consensus market views drifted from clients and prospects. A strategist out of Montreal who more often than not, turned out to be right. For many, Marko, the nihilist Serbian, was their favorite strategist. I realized he was just the stateless, unbiased, enthusiastic, unique idea generator that the team in Santa Monica needed to fill out our global macro squad.
After following Marko's calls for a year and test-driving him at a few client events, I spent the better part of 2018 convincing him that the beaches of Southern California are a better place than the slopes of Mont-Tremblant. In December 2018, Marko signed on to join Clocktower Group as our chief strategist. In 2019, he crushed it. In January 2020, I said, “Marko, that was great, but now it is time to take the training wheels off,” and made him write this book. I've written two books about global macro and was halfway through writing my third: the final installment in my trilogy. Contract was signed, chapters were in the can, and an advance was paid. Halfway through, the world changed. It was time to pass the ball to the big man in the middle.
Marko took the pass and ran with it. Like his childhood hero Kobe Bryant (RIP), he approached this book with insane focus. He wrote chapters faster than I could read them. He did this all while producing reports and talking to clients, seeds, founders, and partners on top of a torn ACL/meniscus (which he ignored), working from home and homeschooling his three kids due to COVID-19. Mamba-style.
Marko has a lot to say about this brave new world that revolves around politics and geopolitics. People deserve to hear it – not just Clocktower clients and friends but anyone who wants their eyes opened to the invisible barriers that dictate the future. In Geopolitical Alpha, Marko models how to make well-researched, actionable forecasts using his constraint-based framework. Along the way, he gifts you, the reader, with funny stories, anecdotes, and historical examples coupled with invaluable insights on relevant geopolitical trends: the state of US–China tensions, the future of Europe, the implications of the COVID-19 pandemic, US elections, and other schisms that will drive world markets. I hope you learn and enjoy. You're welcome.
Steven DrobnyCEO and Founder of Clocktower GroupAuthor of Inside the House of Money and The Invisible Hands.March 2020Currently under “Shelter-in-place” order in Malibu, Claifornia
Introduction
“The German president just resigned. We are selling everything. This is it.”
It is May 31, 2010, and Horst Köhler, the president of Germany, has resigned.
I saw the news flash across my inbox in one of the hundreds of news items that I skimmed every morning, but I ignored it. I had triaged it, along with most articles that day, for the sake of sanity; I thought it was irrelevant.
Several hours later, I stare at the Polycom in the middle of the boardroom at Stratfor, the Austin, Texas–based geopolitical analysis firm that gave me my first job. My decision to ignore this one news item is about to cost me that first job. The knot in my stomach has knots.
The saleswoman whose client – a large Connecticut-based hedge fund – is on the line bores a hole in the side of my head with her gaze. I almost hear her thinking, Oh my God … this foreign kid is out of his depth.
I have no idea why the German president resigned or why it is market-relevant to a hedge fund (I have only a vague idea of what a hedge fund is in the first place). I have no idea who the German president even is!
* * * * *
By May 2010, the Euro Area sovereign debt crisis was already in full swing. The 2008 Great Recession had come and gone without the collapse of Western civilization, but things were still touch-and-go. People were on the lookout for the next shoe to drop. In October, 2009, incoming Greek Prime Minister George Papandreou revealed that the previous government had massively underreported the budget deficit. Instead of 6.7%, the figure was 12.7% (later revised to 15.4%!). The shoe dropped. By December 2009, the greatest economic crisis in the developed world since the Great Depression was afoot.
Nobody at my firm really cared. It was not the fault of the folks running the place; the firm was simply not designed to care about financial markets. For most of the past three decades, the investment and geopolitical communities rarely communicated, in part because they struggled to understand each other. They had become over-professionalized, erecting barriers to entry largely for job security, like medieval guilds.
When the Euro Area crisis hit, my marching orders at the firm were not to spend too much energy on it. I was told to focus on US ballistic missile defense in Europe and some other geopolitical matters that nobody outside the Beltway cared about. We had no edge in covering capital markets – few of the firm's analysts understood their own credit card statements. But as the firm's Europe analyst, it was impossible to ignore the evolving imbroglio. Not only did it flood my inbox with scary headlines and client emails, but I also sensed that this was the career opportunity of a lifetime.
By early 2010, my own career had stalled before it had even really begun. I was on leave from a PhD program at the University of Texas at Austin. Political science coursework and research ware easy, but not interesting. I would have coasted for the rest of my life teaching Poli Sci 101, but the oversupplied labor market in social science PhDs meant that I had to take whatever job was available, even if it deposited me and my family in some academic colony in the middle of nowhere.
I took the job at Stratfor because it was based in Austin. I got lucky. The place was fast-paced, young, and brutal. It taught me not to waffle, to digest information quickly, and to create knowledge shortcuts. But I was still missing the sense that I was making a difference in anybody's life.
My feeling of inadequacy was, in large part, a product of my job description. At the start of the decade, Europe had not produced geopolitical risks for a quarter of a century. The fall of the Berlin Wall, the dissolution of the Soviet Union, and the rise of the world's largest trading bloc were all epic events, but they were all tailwinds in the sails of the global economy. There was a sense that history had ended in Europe and that Jean-Claude Juncker was its Last Man.
At the same time, I was expressly hired to be the firm's Europe analyst. Given Stratfor's roots in “Great Power geopolitics,” my position was the equivalent of being the admiral of the Swiss Navy. Most of the all-hands meetings were about Tomahawks, car bombs, and jihad. I usually got to fight with the Africa analyst for the scraps left over by the Middle East, counterterrorism, and East Asia analysts.
“But … the Lisbon Treaty …” I could feel the sneers before I finished my sentences – sneers from the “real analysts” who subsidized my EU-watching.
Thankfully for my career – and sadly for 400 million European citizens – the Euro Area crisis hit with a vengeance. Even though I couldn't navigate my credit card statement either, I knew that this was my moment to add value.
That said, all this was not clear on the morning of May 31, 2010. I was ushered into the conference room by the salesperson who handled the firm's financial relationships. I tangentially knew what these clients did for a living. Most were passive in their use of the firm's services. They read the analyses we posted online. They gave little feedback. Most of the time I didn't know if anyone cared what I was writing. But over the course of the next 12 months, I would have the most professionally intense period of my life. I realized a lot of people who definitely understood how interest rates worked were reading my research.
* * * * *
“The German president just resigned. We are selling everything. This is it.”
I look at the Polycom. I have a choice to make. Do I waffle my way out of the conversation, or do I bite the bullet?
Something about the accent on the other end of the line instills fear. I think it is a Long Island accent. I cannot tell precisely, as I'm a Serb living my fourth year in the US. Before arriving, all I really understood about America came from movies and The Simpsons. My gut tells me not to waffle “Long Island”; he will know. So, I take a deep breath and ‘fess up.
“Guys, I don't know who the German president is.”
Silence. Uncomfortably long. I glance at my colleague; she is revising her résumé in real time. I imagine my boss decapitating me on the same boardroom table at the next all-hands meeting.
“What do you mean? Aren't you the Europe guy at this shop?!”
Ok, here we go. Long Island is angry. The man pays for a service and is not getting it. I respect that. But the Serb in me now starts to come out. I get irrationally confident for no good reason.
“No … sorry, I apologize. You misunderstood me … yes, I am the Europe guy. And if I don't know who the German president is …” Silence on the other line … time to go on the offensive.
“… Then it is not a significant piece of news. The president of Germany is the equivalent of Queen Elizabeth; he cuts ribbons, kisses babies, and shakes hands at the airport. I don't know why he resigned, but this event has zero relevance.”1
* * * * *
This was a risky move. The resignation could have been related to the Euro Area crisis.
The conventional view at the time was that Germany would not bail out the EU member states. Germans were obsessed with fiscal austerity, risks of inflation, and that “the Swabian housewife saved every pfennig.” Maybe the president was a “hard-money” zealot who objected to bailing out profligate Euro Area peers like Greece. Maybe he thought that the crisis was an opportunity to “liquidate everything” – in the words of former US Treasury Secretary Andrew Mellon, who almost single-handedly turned a severe recession into the Great Depression.
And yet … I had a reason for dismissing this news. I had a framework, and it had taught me to push hard against the Eurosceptic narrative for months. This view on Europe would become a successful investment theme, and the proto framework that I had developed would become my profession and passion over the ensuing decade.
This framework – which focuses on the material constraints policymakers face – is what this book is about.
The framework boils down to this: Niccolò Machiavelli was wrong. No amount of Virtù will help the Prince overcome Fortuna. So don't study the Prince. Study his constraints.
* * * * *
Back in 2010, I take a gamble because “Long Island” pushed my buttons. It is an educated gamble. Long Island's singular focus on relevance – the “so what?” – forces me to make a call. Not to waffle, not to talk about “on the one hand” and “on the other hand,” not to split hairs about “hard-to-estimate probabilities,” but to give him an investment-relevant view in three sentences. The resignation of the German president does not matter. Go back to making money.
“Oh … got it. Thank you. We'll talk later.”
Click.
Exhale.
I straighten up and turn to my colleague, chest flexed, a “What's up?” look on my face while maintaining an air of “I had this the entire time.” (I did not.)
In a slow, staccato voice, she says, “These guys don't know what they are doing.”
Boom. There it is. My Jerry Maguire moment. If we were in a cartoon, a lightbulb would have pulsated above my head and burst. I reply:
“They're not stupid. That guy could literally … buy me … to tutor his kids for the rest of my life. These guys are not stupid. They are just … busy.”
* * * * *
And human. And over-professionalized. To become an investment professional in 2010, one had to be confident in a lot of subjects, but a basic grounding in political science was not among them. This failing is not because investors suddenly became ignorant of global affairs and history but because those skill sets had not mattered for most investors since at least 1985.2
That moment led to a career-altering decision for me. I decided that I wanted to devise a framework for geopolitical forecasting rooted in the real world. Not based on conversations with “wise men in smoke-filled rooms” or on a narrow, inflexible view that geography and history predetermine outcomes, but on actual research and fundamentals. A framework that was not only easy to use but that was replicable by others who sought insights into the future.
There were two reasons I felt confident to declare that the resignation of the German president was irrelevant, both rooted in material constraints. First, the president was constrained by Germany's constitutional irrelevance. Second, I already had a framework for what German policymakers and voters would be forced to accept in the Euro Area crisis. Even if I had been wrong about this particular news item, I had a structural, macro view of what would happen next in the Euro Area crisis, one that was unlikely to unravel due to a single resignation. As I explain in Chapters 4 and 5, the Euro Area crisis illustrates how material constraints impact not only policymakers but also voters. European integration is not only going to continue, it will accelerate over the next decade due to these epochal constraints.
After downloading the constraint-based framework, the reader will be able to stop relying on the news flow for analysis. Much as an anchor keeps a ship from being blown out to sea, constraints anchor the smart investor to a subjective probability grounded in material reality.
I take one chapter to describe this framework. The punchline: investors (and anyone interested in forecasting politics) should focus on material constraints, not policymaker preferences.
Preferences are optional and subject to constraints, whereas constraints are neither optional nor subject to preferences.
The era of geopolitical ignorance is over. The days when investors and corporate decision-makers could be successful without much understanding of politics will be a footnote in the annals of history. In the first chapter, I go over these paradigm shifts rather quickly because, at the time of this writing, the idea that “we're not in Kansas anymore” is obvious.
At the same time, not everyone needs to rush to enroll in political science courses. The constraint framework has worked well for me by providing the tools sufficient to make sense of politics. As such, I hope to offer professionals who must take politics seriously a shortcut – not a foolproof, scientific method – to forecasting geopolitics.
The focus of the rest of the book is on the framework itself. While I initially built the constraint framework to help investors make sense of geopolitics – and make money in the process – the C-suite can also use it to make long-term investment decisions. Journalists can use it to find the right buttons to push in an interview, and voters to become more politically informed.3
Chapter 2 describes the inspiration for the constraint-based framework. It is a mix of political science, political theory, intelligence analysis, and social psychology – as well as voodoo and trial and error.
Why read beyond the first part that describes the framework? It is one thing to hear the framework described; it is another to see it in action. It would be like telling a budding skier that skiing comes down to balance and reading the terrain. Sounds awesome. Now plunge yourself down a double black slope. I therefore take the framework for a spin, using recent geopolitical and political events as the racetrack. The book concludes by operationalizing the framework in a process that gives us the title: Geopolitical Alpha. Alpha, in the context of this book, refers to a return on an investment against a benchmark, in finance-speak, rather than the leader of a pack or someone spending too much time in a gym.
There are three things this book does not aim to do.
First, it cannot teach you about the world. To wield the constraint-based framework competently, you must know a lot. For instance, that the German president = Queen Elizabeth. If you don't know, speak to experts. That potential absence of a knowledge base is why I include a chapter on how to use expert judgment.
Second, this book will not tell you the future. This is a methods book. I offer up my framework because many investment professionals have found it useful. But I am not a prophet, nor will focusing on constraints make anyone else a prophet. This book is simply my attempt to share what has worked for me. There are other frameworks out there that work for other investment strategists.
Third, this book will not tell you what I think should happen.
I don't care. Not in this book, not in my field. I am a professional nihilist. And if you analyze politics for a living – especially if you have a fiduciary duty to your investors – you should be the same! To competently use my framework, meditate on your biases and bathe yourself in indifference. If you are not up to it, you should not be in the forecasting business, let alone finance.
Notes
1
German President Horst Köhler resigned because, in 2010, it was still not acceptable for a German statesman to say that Berlin would use its military to protect its economic interests – such as to keep trade routes open. He was widely respected and a popular, nonpolitical leader. Ironically, his successor (who also resigned) later said much the same thing with little fanfare and no pressure to resign, showing how quickly the world was evolving in the early part of the 2010s.
2
Most does not mean all investors. Many of the greatest macro hedge fund minds of the past three decades made smart calls based on correct geopolitical insights. For example, George Soros “broke” the Bank of England in 1992 by understanding that the Bundesbank may burn deutschmarks defending the lira and the peseta, but not the pound. Aside from the occasional story of an astute geopolitical insight leading to fame and fortune, most professional investors have not had to care about geopolitics in their daily lives for a very long time.
3
By the way, if you have
that
relative at every family gathering, this is a perfect book to get them for the holidays!
Part OneSCAFFOLDING
Chapter 1We're Not in Kansas Anymore
The world is undergoing paradigm shifts on multiple fronts: political, geopolitical, generational, and technological. What these changes are and their implications for the future are beyond the scope of this book. Instead, I present a framework that has helped me make sense of the world over the past decade. I hope it will prove helpful to navigate the paradigm shifts to come.
I use the term “framework” because it is less deterministic than a theory and not as prescriptive as a method. It is messy, full of contradictions, and much more art than science. It fits with forecasting geopolitics and politics because forecasting is similarly messy. There is nothing parsimonious about the constraint framework I present.
In the past 25 years, geopolitics and politics have switched from being tailwinds to the global economy and markets to being headwinds. For many in business and finance, it feels like a rug has been pulled out from under them. I know the feeling; I saw it happen to my family firsthand when I was eight years old.
Cut off from the Yellow Brick Road
In 1986, my 36-year-old dad joined General Export (Genex), the crème de la crème of Yugoslavia's corporate world. For my dad, it was the equivalent of landing a job at IBM in the 1950s-era United States.
Dad had made it. His life – and by extension my life – was going to be pure kajmak.1 Step one: a four-year stint in the London office (“so you and your sister can learn English”). Steps two and beyond: an upgrade to our 505-square-foot “condo,” then maybe a car with more than two cylinders, a house on the Dalmatian coast, a year at a foreign university … culminating in an entrée into the upper echelons of socialist society.2
What was so great about Genex? At the end of 1989, the conglomerate controlled 12–13% of Yugoslav foreign trade and nearly a third of Serbian trade with the rest of the world.3
What did it manufacture? What services did it export?
Nothing and none. What Genex “manufactured” was pure geopolitical alpha.
The Soviets did not believe in running a trade deficit. So, every year, the USSR would produce a list of goods that it was interested in exchanging for barter. Because Yugoslavia was a promiscuous communist country – it played both sides of the Cold War – a company like Genex would sell Yugoslav and foreign goods to the Soviets in exchange for what the USSR was willing to export (mainly commodities). Genex would then sell the Soviet commodities in the global market, pocketing a hefty profit in hard currency.
Unfortunately for Genex, but fortunately for almost everyone else on the planet, the Berlin Wall fell on November 9, 1989. Two years later, the Soviet Union disintegrated. The geopolitical gravy train ended and Genex's edge with it. The firm's entire corporate strategy was leveraged to the geopolitical status quo. In fact, my homeland was basically living off the Cold War. When the geopolitical winds shifted, the end was nigh for both Genex and Yugoslavia.
Thanks to the combination of a massive geopolitical paradigm shift and epic mismanagement, Yugoslavia in the 1990s was worthy of a chapter in Jared Diamond's Collapse. The near-first-world life that my family built in Belgrade descended into hell in weeks.
The country's currency, the dinar, was devalued 18 times in seven years, with 22 zeros erased from its value.4 The monthly rate of inflation peaked at 313,000,000% in January 1994 – at the time the second-highest recorded rate of inflation.5 Between February 1992 and January 1994, the price level in Yugoslavia rose by a factor of 3.6 × 1022.6 I have an academic footnote to prove it.7
My hometown of Belgrade came fourth in the 1986 vote for the 1992 Summer Olympics. But by 1992, it had descended into an episode of The Walking Dead. In May 1994, my family left Belgrade with two suitcases. Destination? Amman, Jordan.8
Thankfully, my dad saw it coming, so he quit Genex a few years before the deluge. He got a job in a direct sales company selling cooking pots. He went from faux IBM to essentially Tupperware.
Many years later, whenever I fretted about my grades or school in general, he told me, “Relax. Why are you stressed? Do you know what Marx and Engels have to say about direct sales? Nothing. All my university exams and work experience are useless for the damn job I do today.”
If you are a CIO of an institutional investment fund, a portfolio manager in an asset management firm, or a C-suit executive, you also face geopolitical paradigm shifts that will, at best, make your work more challenging. At worst, they will collapse your civilization like they collapsed my father's. In this book, my intention is to offer you a framework with which to prepare yourself for the former possibility. For the latter, I've got nothing.
Investors are all in the same predicament that my dad faced at age 36. The training, certifications, and experience of the past 35 years have woefully underprepared the West's financial and corporate communities for the paradigm shifts that are occurring.
The End of the Goldilocks Era
Politics and geopolitics have shaped investment and business decisions for centuries. In his seminal work, The House of Rothschild, Niall Ferguson describes how the Rothschild family – well-versed in geopolitical analysis – became the richest and most powerful family of the nineteenth century. Adam Smith named the bible of economics An Inquiry into the Nature and Causes of the Wealth of Nations. Not people, not companies, nor corporations, but nations. And while John Maynard Keynes is most renowned for The General Theory of Employment, Interest and Money, he showed the range of his genius in The Economic Consequences of the Peace (1919), where he correctly forecasted the rise of the populist right, the Second World War, and even the European Union.9
For centuries, success in business and investing required the skills of both long division and sensitivity to political and geopolitical change. Yet today the curricula of most MBA programs – and the CFA curriculum in its entirety – ignore the latter.
For the better part of a quarter-century, between 1985 and 2008, election results in most large markets made little difference to the price of assets or company earnings.10 For the vast majority of investors, politics and geopolitics were worthy of a one-hour meeting at the start of the year or, at most, a small expense on the research/consulting budget.
Politics and geopolitics still played a role, but in the background, working as a tailwind in the sails of investors. Events and paradigm shifts played out into the hands of the multinational corporate and financial communities. As a result, a new crop of investors emerged out of this Goldilocks Era who were overquantified, while the gray-hairs and their cautionary tales receded into neglect.
Since the collapse of the Soviet Union, American hegemony meant that wars either occurred in investment-irrelevant countries – Rwanda, Armenia, Azerbaijan, Moldova, Somalia, Bosnia and Herzegovina, Lebanon, etc. – or were finished quickly, such as the First Gulf War or the 1999 North Atlantic Treaty Organization (NATO) air war against Serbia.
By the time I entered the financial industry in 2011, few if any of my clients and colleagues had ever had to make an investment decision based on geopolitics. The world's premier political risk consultancy – Eurasia Group – announced in its very name that its focus was on the fringes of the corporate world. By “Eurasia,” Ian Bremmer – the firm's founder and a visionary in the field of political risk analysis – meant the frontier markets of the former Soviet Union. In 1998, Bremmer's vision was that political risk analysis would matter for “the Stans” and few others.
Why?
The answer lies in Mikhail Gorbachev's 1985 “Leningrad speech” – the one where he lambasted the Soviet leadership and launched perestroika (“restructuring”).11
By the late 1970s, the Soviet Union was in the midst of a deep economic malaise. Living standards had stopped improving throughout the decade, and the Soviet Union fell far behind the US in terms of technological advancement. Gorbachev threw in the proverbial towel in the contest between a statist-planned economy and a free-market one.
By conceding the defeat of communism in the Soviet Union, Gorbachev undermined it in the rest of the world. The consequence of this ideological capitulation was the Third Wave of democratization and the adoption of free-market policies across the globe. Within a decade of Gorbachev's speech in Leningrad, free-market capitalism became “the only game in town,” and within two decades, 90% of the global population was living in capitalism (Figure 1.1).
Figure 1.1Perestroika launched the largest supply-side revolution.
The strategic victory of the US over the Soviet Union complemented the ideological victory of the free market. With the dissolution of the Soviet Union, the US became the sole superpower capable of enforcing norms of state behavior on a global scale.
The US did so by challenging revanchist regimes that were willing to challenge the new status quo, such as Saddam Hussein's Iraq and Slobodan Milošević's Yugoslavia/Serbia.12 It also supported the new capitalist orthodoxy by encouraging international economic institutions to promote macroeconomic reforms, dubbed the “Washington Consensus.”
The defeat of demand-side policies in the Thatcher–Reagan revolution of the 1980s occurred alongside the Soviet defeat. Profligate fiscal policy, politicized monetary policy, and an inflexible regulatory regime had saddled developed markets throughout the 1960s and 1970s, culminating in dramatic inflation that was only exacerbated by the “oil shock” following the 1973 Yom Kippur War.13
In response to this economic malaise, UK Prime Minister Margaret Thatcher instituted her neoliberal shock therapy. While the initial outcome was a recession and elevated unemployment, her policies eventually led to an economic recovery in the late 1980s. Thatcher's tax cuts, privatization, and deregulation became the pillars that would underpin the Washington Consensus – and laissez-faire economics in general – that countries would replicate across the developed and later the developing world.
One country that rejected the supply-side revolution was France. In 1981, in the midst of the rightward policy turn in the UK and the US, France elected socialist François Mitterrand. Mitterrand ran on an unabashedly left-wing policy package called the “110 Propositions for France.” The package of reforms included price controls, reregulation of industries, minimum-wage increases, public works programs, a massive public-sector job program, nationalization of major industrial groups, reduction of the working time, a wealth tax, and an extension of trade union powers. Mitterrand's surprise electoral win led to two major runs on the franc in the year after his victory and the resulting near ignominy of contemplating aid from the International Monetary Fund (IMF).
In the battle of ideas, the Thatcher/Reagan supply-side – laissez-faire – won as decisive a victory over Mitterrand's demand-side –dirigisme – as one could imagine. Voters and policymakers across the developed world took note and adjusted behavior accordingly.14
By the mid-1980s, the twin tailwinds of laissez-faire economics and American geopolitical hegemony created the ultimate Goldilocks scenario for investors and C-suite executives alike.
On the geopolitical front, hegemonic stability – in the words of Charles Kindleberger – prevailed.15 The George H.W. Bush and Bill Clinton administrations enforced that stability when they engaged with the rest of the world.16 The US foreign policy establishment, staffed mainly by foreign policy hawks who cut their teeth on the Cold War, favored an activist and engaged foreign policy, one that ensured the US would continue to provide the expensive global public goods necessary to grease the wheels of economic globalization.
The Tornado Hits Kansas: Geopolitical Paradigm Shifts
Hegemony sows the seeds for its own decline. America's policing freed up other countries to strengthen their own economic independence. By ushering in stability and globalization, the US allowed countries to set aside their challenges to US hegemony and focus on economic development. But those material gains ultimately allowed these challengers to get to the point where they could challenge the US for hegemony. This is the story of the rise and fall of empires; stability breeds collapse.17
In the wake of the Great Recession, a messy, multipolar world has replaced American hegemony.
Multipolarity is a concept from political science that describes a world in which no single entity (unipolarity) – and no two entities (bipolarity) – possess a preponderance of power with which to impose order in an otherwise anarchic system. Instead, multiple countries pursue their national interests independently, an arrangement that forecasters know – from history and political science theory – produces high geopolitical volatility (Figure 1.2).18
Figure 1.2 Multipolarity begets disequilibrium.
Think of the 2014 Russian annexation of Crimea or China's militarization of the South China Sea since 2012. Both would have been unthinkable during the post-Cold War era when the US was invested in maintaining a global balance of power.
Without a single hegemon to enforce rules of behavior, globalization reached its apex in the past decade. This sequence of events did not require the election of a populist to divine. Deglobalization is structural and thus difficult to reverse. For globalization to persist, one or more states need to bear the high cost of global public goods, such as defense of trade routes, global economic policy coordination, the role of a consumer of last resort, and the continued defense of rules of behavior, such as state sovereignty and noninterference. It was difficult to imagine any country filling this void in the 2010s, and it still is in the coming decade.
Finally, the Great Recession of 2008 and rising income inequality in the developed world undermined the laissez-faire economic system. While globalization lifted billions out of poverty across the world, it also expanded the global supply of labor, weighing on wages for the middle class across the developed world (Figure 1.3).19 Wage stagnation is not the only source of malaise in advanced economies, but it is a powerful one.
Figure 1.3 Developed world middle classes stagnated amid globalization.
That said, the political reaction is not uniform across the developed world. In the US and the UK, the populist backlash was the strongest, in part because the two countries most enthusiastically adopted
