The Geopolitical Tug-of-War: Russia, China & the West ft. Marko Papic

[00:00:00] Marko

I think that it’s pretty clear that the world is more multipolar than bipolar. But what you’re saying is definitely something the US has tried to create; very hard at working, very hard at trying to create a very clear bipolar structure because it would solve all of America’s problems. If you could convince Europe and Japan and South Korea and India that look, you’ve got to pick one or the other camp, if you could convince the rest of the world that this is the reality, it will be game over for Russia and China at that point.

[00:00:39] Intro

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Here’s your host, veteran hedge fund manager, Niels Kaastrup-Larsen.

[00:01:29] Niels

A new world order is becoming clearer by the day, and in our Global Macro series, I along with my co-host, Cem Karsan, want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macro-driven world will look like. We want to explore their perspectives on a host of game-changing issues and hopefully dig out nuances to their work in places that others may have missed, and we want to share our journey with you.

Our guest today is one of the most sought out people when it comes to understanding the geopolitical shifts that we are witnessing right now. So please enjoy our conversation with Marko Papic.

Marko, welcome back to the podcast and thank you so much for joining Cem and I today for what I’m sure will be a fantastic and fun conversation as part of our Global Macro series.

Now, last time you were on the show was back in December 2022 and things were very different back then. First off, the world was still licking their wounds from COVID. We did not have a new conflict in the Middle East and we did not know at the time that the US presidential election would be a rematch between Biden and Trump with a Kennedy as an outsider. So I think we’ll have plenty to dig into.

Now, back in the spring of 2022, Cem and I spoke to one of your former colleagues, Peter Zeihan, and his message really was that the world we knew was coming to an end. But I remember that you had somewhat a more optimistic view when we spoke to you later that year.

So I’d love for you to express your big-picture assessment of where you think we stand today and what has changed for you since we last spoke, and also maybe what people are focusing on in the conversations you’re having with your clients right now.

[00:03:25] Marko

I would say that Peter Zeihan is right. The world that we have all known has ended. I would argue that that world had ended really in the early 2010s, and that is the world of American hegemony. What that means is not some sort of end of America or anything like that. It just means that for a unipolar world to exist, for one country to dominate, it has to have preponderance of power.

That doesn’t mean that you need to just be head and shoulder above everyone else. It’s head, shoulder, torso, hips, above everyone else in the world, so that that country can compel everyone else to do whatever it wants without so much is picking up a phone. This is the kind of world that did exist either since the 1990s in a unipolar kind of setting or a bipolar setting which we all of course remember very, very well, which was the Cold War where there were two kinds of countries with preponderance of power. They would beat up with all their allies, keep them in line.

This is a world that we as investors knew and it’s easy to model. It’s a bipolar distribution of power or a unipolar world, easy to model, easy to put into a framework, and it’s a world that tends to be very orderly, more or less. So that world is over. A lot of people see that in a negative light. There is a negative consequence of a multipolar global ordering of power and that negative consequence unfortunately is that conflicts are easier to form because there is no one bully or two bullies to keep the world in some sort of a check, in some sort of equilibrium.

But, as I’ve argued for a while now, that world can also have ancillary benefits such as pretty significant technological innovation in the spirit and in the pursuit of that geopolitical competition. So the government gets more involved in innovation, financing true technological outbreaks. Also, that kind of a world can lead to pretty interesting, not just technological innovation, but also industrial innovation, productivity, because there is geopolitical competition between states and so they are focusing on far more significant issues that matter such as infrastructure development, building up their own domestic capacities.

That leads to interesting outcomes that we can’t foresee right now. Anyways, both of those kinds have been correct, I think, so far. We have had more conflicts emerge between countries that you would not have necessarily expected. And also, we’ve seen governments put more effort into becoming capable in different technological verticals. So yeah, I would say that it’s not the end of the world in a negative sense, but it is end of a world, a world that we are comfortable with mentally.

In terms of what investors are really focused on, I would say in the short term, everyone was really just focused on the US election. No one is really focused on anything else. Ukraine-Russia conflict has fallen into the background as I expected. That’s one of those very, very interesting outcomes of a multipolar world where you can have a higher frequency of conflict, but it doesn’t mean that they all matter that much to macro, to global investors. And then of course Israel-Hamas conflict is also relevant but most investors have also put that into the background as well. It’s all about the US election right now.

[00:07:17] Niels

Cem, where do we go from here? There’s so much to pick from.

[00:07:20] Cem

I find that actually fascinating, Marko, because I’ve come to the exact same conclusions over the last five years, but for very different reasons. I absolutely couldn’t agree with you more. The change really started around 2010 if you were to put a mark on ’09 from going from this kind of unipolar world to multipolar. The reason I see it happening is more a function of inequality, wealth inequality and populism.

We’ve seen cycles like this before. We started to see here in the US Occupy Wall Street and the Tea Party, all these movements, but in terms of generational push that was happening with this populist push, it really didn’t get to a critical mass until really Bernie Sanders, Donald Trump, all these populist leaders really picked up on that and came to power.

We’ve seen other periods like this in the past, but it really has, in my opinion, led to this multipolar world because, this I think is the connection, populism leads to protectionism. It’s this idea that people are local, corporations are global. So I think it’s very interesting. I think your framework frames it more as a secular issue, that we’re moving to a much more long-term period maybe 20, 30, 40, 50, maybe 100 years of more multipolar activity, whereas I really see it as a 10, 15-year phenomenon where that populism fades eventually. We’ve seen these sorts of cycles. I’d love to hear your thoughts about that differentiation.

[00:09:08] Marko

No, I don’t disagree. I don’t think I can really forecast beyond a strategic asset allocation time horizon. So I think 10 years is really all I’m going to say. My former boss, George Friedman, wrote a book which was “The Next 100 Years”. It was a New York Times bestseller. It was a lot of fun because he could say whatever he wanted. I think the book ends with Japan and Turkey fighting in space with Death Stars. So let’s not go beyond 10 years. Let’s stick to what you’re saying.

First of all, I agree with you. There are two dimensions of the evolution that investors have to become aware of. One is a geopolitical evolution where the collapse of the Soviet Union ushered in a unipolar moment. It was great for us because we didn’t have to really take geopolitics into consideration at all. They was just US hegemony. I think that is at an end for a number of different reasons.

The US is still the most powerful country in the world I think quantitatively. It’s not about head and shoulders as I said, it’s a lot more than that. You need preponderance of power. So that’s number one. Number two is exactly what you’re saying. I describe your point in my book actually. I spend more time on that because the geopolitics is not that interesting to me. It’s obvious. The US doesn’t have the preponderance of power anymore.

But what’s less understood by investors is this evolution away from laissez faire capitalism, this Reagan-Thatcher revolution, which gave us the best practices of the Washington Consensus, which was all the policies that emerge out of the Reagan and Thatcher moments, which was the late ’70s, early’80s when the world oriented itself away from dirigiste capitalism of the 1970s, which of course gave us suboptimal outcomes. And that’s where I do agree with you.

The pendulum is starting to swing actually already away for what I call the Buenos Aires Consensus. Will that fix the multipolar distribution of power in the geopolitical sense? I’m not sure guys. You can have a very laissez faire capitalist global system where every country is kind of like, yeah, you know what? State involvement in capitalism, not a good idea. You can have that world and still have a multipolar ordering of power. That’s actually what happened in the late 19th century.

If you think about it, late 19th century regimes were very much influenced by the United Kingdom and its successful period of hegemony, and so laissez-faire capitalism was the name of the game in the late 19th century, so 1880s, 1890s, 1900s, 1910s, and yet the world was extremely multipolar. So that’s the only thing I would disagree with. I think we can have this pendulum swing away from the current left-leaning Buenos Aires Consensus where you do have less laissez-faire, more dirigiste capitalism.

You can have it swing back towards laissez-faire capitalism, I’m just not sure that it’s going to reaffirm American hegemony or resolve multipolarity. So I think we’re kind of stuck, for the foreseeable future, in a world where more than 2, probably around 5 to 10 countries can pursue foreign policy independent of one another. And I think investors should prepare for a world where conflict, military conflict has higher frequency, but I’m not sure that you’re going to have to trade every one of those.

I’m not sure that this is something that’s going to really change the world. In fact, my impulse is to almost fade every geopolitical event and then invest in geopolitical trends. So to me, geopolitical events are fleeting, they should be faded, especially in a world where their frequency is higher and they don’t necessarily produce the kind of global impact you would expect.

Think about Ukraine and Russia. You guys and me, we’re like 10 minutes into the interview, not a single question. 2022, it’s all about Ukraine and Russia. Think about that. Israel-Hamas, again, nobody’s really asking questions about those. We can talk about them but that’s because you can have a higher frequency of conflict with less relevance, and that’s the world that I think we’re in for at least 10 years.

[00:13:36] Cem

I completely agree with that comment. It’s very much germane to the volatility work that we do as well. There’s a general sense that periods like this of deglobalization and conflict that we see are more volatile. It actually works out that you have more frequent events that can be volatile, but broad volatility is actually significantly lower, which again, you wouldn’t think about, and it’s because of a more consistent trend towards more understanding of what’s happening as well. So I completely agree with you. The data that actually backs it up.

[00:14:14] Marko

Before you ask me your next question, just to piggyback on that point, I just want to say, what’s interesting, I have this chart of S&P 500 reaching all time highs and ever higher volatility levels. That’s a great way to visualize the world we’re in. We can have this higher volatility level, just baselines higher, but stocks don’t care. Their risk assets are like okay, cool, we get it. It’s a messier world. You can still go higher.

[00:14:44] Cem

I agree with that. To build on a couple of those ideas too, during the ’60s and ’70s, the nearest period we have that, in my opinion, tracks some of this deglobalization and more multipolar world as you reference, people talk about the causes of that. They refer to the Vietnam War, OPEC crises, fiscal stimulus and more protectionism during that period as well as leading to inflation.

But I really see them as all the same thing, which is basically what you’re pointing to as well; this period where broadly everybody’s really in a period of conflict as opposed to cooperation as a function of worrying about their own people. I’m curious to hear your thoughts on the type of things that you see happening if you believe this period is going to be going on for 10 or 15 years. Are there things that are on your radar that we haven’t seen yet potentially that other people aren’t looking for?

[00:15:56] Marko

Yeah, I do. Absolutely. Let’s go into the meaty stuff. This is very much by the way a strategic asset allocation discussion right now, not really a tactical one, which is fine. I’m always more comfortable with the beta rather than the alpha. I titled my book by the way “Geopolitical Alpha”, and then after publishing it and getting a lot of feedback, I was like, yeah, I should probably call it “Geopolitical Beta” now that I think about it.

So let’s talk about this because what is not priced in? What happened in the ’60s and ’70s that is yet to happen is really your question. So first of all, why did we have the 1970s inflationary higher world than we did? There’s a lot of reasons, but I don’t think it was OPEC’s fault. My colleagues, my former colleagues at BCA Research did a lot of great outputs that show clearly inflation was going up well before any oil shocks, and it was going up for many reasons, but one of them, and I think the most important, is exactly what you’re saying.

We had the Great Society of Lyndon Baines Johnson. So it wasn’t just about geopolitics and oil supply. It was also about domestic policy. It was about income inequality. It was about the civil rights movement. It was about LBJ basically writing a procyclical fiscal policy, stimulating the economy when there was no reason to do it. There was no real recession. But the country was really tearing itself apart in the ’60s for a number of different reasons.

The Civil Rights Movement was a very, very difficult thing to evolve through and to integrate and to implement, and so fiscal largesse was the aloe vera to soothe all these policies through. And of course, Vietnam War was part of that as well. So you have a considerable amount of fiscal largesse that happens that sets us up for the inflationary world in the 1970s.

I think one of the reasons that LBJ’s administration was comfortable with some of these outlays is that also in the early ’60s, don’t forget, we had secular stagnation. So we had a low growth, low inflation period, in the early ’60s and the late ’50s, that put policymakers into complacency about fiscal policy. They started spending a lot and then we had inflationary outcomes. That’s grafted almost exactly to our experience right now where we had secular stagnation after the great financial crisis, policymakers get complacent.

They’re like, well, maybe we shouldn’t use some of this fiscal. They do. They do it too much after the pandemic and then we get the situation we’re in. So what’s the difference? Well, one difference, which is a massive difference between now and then, is long-term inflation expectations. Long-term inflation expectations right now or acting as if nothing happened.

I have this chart in my chart bag of like five-year five-year forward, some breakevens and survey expectations, just like whatever. And it’s an hilarious chart. It’s like 2020 happens and it’s like anchored at 2.5 to 3, 5-year, 5-year forward is like 2.5. Surveys are at like 2.83. Nothing, nothing to see here, folks. Move along. These are not the droids you’re looking for, like whatever you want to say. And I’m sitting there and I’m telling my clients, look, this is what hasn’t been priced in.

We have had a profound change. As Peter Zeihan says, it’s the end of a world. It’s the end of the world that we know in globalization, in the way we approach climate change and energy policies, in the way we approach rivals and potential trade partners like China. So basically, I joke, everybody woke up one day after 2020 and decided China’s evil. Everybody woke up one day and decided climate change is going to kill us within, not in the next 30 years, but 5 years.

Everybody woke up and decided we needed to abrogate all trade with the largest commodity exporter in the world, which is Russia. Everybody woke up and said, “Ah, free trade. Nonsense. All that laissez-faire stuff, that was 100% wrong. Let’s go into this dirigiste stuff. Let’s grow our way into productivity. Fiscal spending will give us new technologies.” Everybody woke up at the same time and shifted this way, and the 5-year 5-year forward hasn’t budged. Long-term inflation hasn’t never budged.

Now, I do think that there are many, many differences today from the 1970s, which is why we’re not going to have the kind of inflationary outcomes from the ’70s. Can I get like 50 basis points or 100 on the long term? Can I get 50 basis points on the long-term inflation? That’s all I’m asking for. Can we be at 3%, maybe 3.2% on the 5-year forward? Three-year breakevens, can they go up a little bit?

That’s what I think is the most mispriced. And that really matters because the 10-year yield is at 4.3%. It touched 5%, the 10-year yield. US 10-year yield touched 5% at the end of 2023 with long-term inflation expectations not having budged at all. That just tells you that the fair value yield could be actually much higher if we do get that movement.

The other thing that I think is interesting is if you look at gold prices relative to long-term real rates, it’s a one-to-one correlation. Gold is a non-yielding asset. You don’t want to have it when real rates are high. Right now, gold prices are above $2,000 whereas they should be at above $1,000 according to that chart. That tells you either gold prices are in for a massive collapse or the way we deflate long-term interest rates to get the long-term real rates is not right.

In other words, again, long-term inflation expectations are wrong and gold was right. And I think that latter conclusion is my conclusion.

[00:22:09] Cem

I couldn’t agree with you more. Actually, it scares me when I agree with somebody as much as we agree. It’s the one thing that doesn’t fit. It’s the one piece that doesn’t fit. The name of the show is Top Traders Unplugged. That’s what I do. I manage money. And that’s the one thing that makes little to no sense. The question is, why? That’s the real question. Why?

I think the interesting part is, the one thing that is very different in the ’60s and ’70s is how financialized the market is and the introduction to derivatives. The reflexivity is much more powerful to financial markets themselves. And I think that’s why you get some of these big structural mispricings that can last for quite some time. You almost need the counterintuitive opportunity, at this point, to exist in order for that pricing to come to fruition.

It’s really this macro versus flows reality now. The flows are so much more dominant than they used to be. So I think that’s why it’s mispriced. I agree with you, it’s still mispriced. At the end of the day, macro still will trump the flows. But sometimes you’re going to need to take a path that is going to make that trade have to be counterintuitive to reach an ability to come to fruition. But I couldn’t agree with you more on that mispricing.

I’m going to shift gears a little bit here. What I find interesting is we do agree on all these things and it seems like, if these are the trends, there are certain types of secular things that you should be investing in. Obviously, commodities and harder assets, government spending, things that benefit from government spending, infrastructural, national defense, healthcare, housing, investing in the economy instead of the market.

What I mean by that is high DCF value, the high-quality businesses have money. That kind of Warren Buffett style of investing should come back, and deglobalization, onshoring, nearshoring, etc. So all those things seem like these are the things you really want to be focused on investing in secularly if this is where we’re going. But you brought up a couple of things recently that really made me question some of these things in the short-term and I want to bring those up and dive in.

One, you mentioned the election, but there’s this Donald Trump factor. He’s this really iconoclastic politician who, much like you said, only Nixon could go to China. Trump himself could be the one to actually buck some of these trends, particularly in the short-term, and bridge some of the gaps with China, which are major drivers of a lot of these trends; the number one and number two economies and the fissure that’s happening.

Does Trump have other things that he wants to accomplish for himself and for others that lead to a deal or that can bridge some of this deglobalization? That’s one thing that really got me thinking a bit lately that could buck some of these trends. The other one is just the amount of investment on the commodity side, particularly LNG, that could solve some of the commodity issues that Europe in particular is having and bring supply on to help some of those things. So I’d love to explore some of these countertheses together and dive into that. I’d love to hear your thoughts.

[00:25:55] Marko

I don’t think that my view on the Trump presidency, foreign policy, trade policy is necessarily going to reverse what may be called deglobalization. I think he just lands the plane. That’s it. I just think that Donald Trump took off with a plane, he’s the only one that can land it. What do I mean by this? What I mean by this is that Trump unleashed this nationalist protectionist move in US trade and economic policy obviously.

He identified that the median voter in 2016 was not really interested in TTP. Hillary Clinton had to pivot right through the election campaign on this issue. So he identified voters were ready for some protectionism. But his intention was always like, I’m going use this as a bludgeon, as a tool, and then get deals. So I think that in that way, he’s the only person who can land that plane.

The Biden administration cannot. In part, it’s not just incompetency. I don’t think that’s the problem. I think it’s more that the political system in the US is unfair to the Democrats. It’s very difficult for them to sell any kind of a free trade deal in this environment as being legitimate. It’s just very difficult. That’s why the Biden administration didn’t conclude a single one. It’s very difficult for them to make any deals at all.

So I think that Donald Trump will be able to get those deals done even with China. Just to be clear, what I’m saying is it’s not like he will bring about the 1990 style globalization, but he will be able to conclude trade deals and foreign policy deals with rivals with very little resistance domestically, and that will allow him to do those deals. Some of them will probably include Chinese companies building factories in Ohio as he recently said at one of his rallies.

He was in Ohio giving a pre-election rally in front of a crowd I’m sure of many, many unionized manufacturing workers, and he’s telling them, I’m going to force China to build factories in the Midwest to help us. I could imagine Joe Biden attempting the same thing and inciting a riot. That’s very important because it doesn’t mean that he reverses and brings back the kind of globalization we had before. It’s still very much a CapEx-intensive type of environment where we’re still redesigning supply chains, which requires a lot of commodities, it’s probably less efficient.

From a purely mathematical perspective, you probably don’t want Chinese EV factories in Ohio. You probably want them where they are currently for efficiency’s sake, but fine. For political reasons, the Chinese will say, okay, fine, we’ll do what we have to do. So that’s what I’m saying. He doesn’t really reverse the entire environment, but I think he just lands the protectionism plane. I say he lands it because it resolves some of the issues that both America has and that China has. It actually creates a new stable equilibrium.

By the way, one interesting thing about this is the Chinese are already doing this. The Chinese are literally spending their own money. The Chinese are literally investing in American national security priorities. What? Time oyt. Say that again, Marko? Yes, the Chinese are literally spending money on satisfying American national security priorities. They are themselves what I call enemy-shoring.

Who is the biggest investor source of FDI in Vietnam and Indonesia, and for a little bit there, even in Mexico? In 2023 and 2022, Chinese FDI into Mexico skyrocketed. So the Chinese have basically accepted that they have to rebuild the supply chains and move these factories away because the Americans are just not going to let them build as much within their own borders.

So the Chinese companies themselves are moving around already satisfying this demand. And so what you see in trade balance terms is US trade deficit with China is improving, but with the rest of the world, it’s deteriorating massively. So it means globalization continues, but just within the framework that Trump created in 2016 and ’17. So that’s the first thing that I would say. On the other issue, yeah, LNG, there’s overinvestment. As it is with commodities when there’s a supply problem, we panic, we overinvest.

I think that overinvestment was already built into the system way back. We’ve got a lot of LNG coming online out of Qatar, Russia, Canada, Mozambique, US. And so, in two years Europe is going to be flooded. It’s going to be drowning in LNG. My thesis on that one is just European energy crisis is over. And so if you want to invest in this deglobalizing world where CapEx requirements are really high because we’re rebuilding very efficient supply chains, if you want to invest somewhere, you want to invest in European industrials.

They’re already set up to win in this world because they’re good at building machinery on CapEx goods. They’re already good at that. But now they’re going to have this advantage of cheap electricity over the next two years. Currently, they’re trading at a discount relative to their American peers as an example, purely I think because of this economist cover fueled Europe is going to deindustrialize. No, it’s not. It’s going to continue being industrial, and in fact, it’s going to have an energy advantage.

So I would argue that both of those theses that you brought up are actually tuned to the world that we’re in. There’s just a little modification on the thesis.

[00:31:49] Cem

Yeah, absolutely. I couldn’t agree more. That’s a great way to put it. But I do think it does highlight that even within a secular trend, if you just got right that monetary policy and growth, all the trends that we had for the last 30 years were going to be in place, you would have been incredibly wealthy, but you also would have lost 90% in the NASDAQ from 2000 to 2002.

So, I think it’s important to get the secular trends right but realize that in the short term, meaning one, two, three years even, you can get completely blown up being massively long a secular trend in the short term. And I think something like this election represents a really important time to be incredibly careful. Even if you’re right on that secular trend, you could be very wrong for a couple of years.

[00:32:40] Marko

When I speak to clients, I say the election is like a macro black hole. It bends time and space around it. I think one of the things that the election has done, we’ve spent about 20 minutes now talking about secular things, multipolarity, higher inflation, all this good stuff, but really the last six months has been about one thing and one thing only. The election is coming, election is a risk.

The Fed is like, we’re going to take some left tail risks off the table. And so they produce the right tail risk. They took the left tail risk off the table. They don’t want a Silicon Valley Bank like event ahead of an election. Is it because they want Joe Biden to win? I don’t need that argument to see why they want to take left tail risk off the table, but yes, I do believe that the Fed wants Joe Biden to win for sure. This is all that matters for the next six months. CapEx cycles, industrialization, deglobalization, higher inflation, who cares?

For the next six months, it’s all about November 5th and then November 6th. That’s why in December of last year when I wrote my annual forecast, I set my S&P 500 target at $5,500. I actually asked my team, give me all the investment bank targets, was the mean $4,750? Yolo. Let’s go. $5,500, just to troll the investment banks. That’s why I did that. And then I thought about it a little bit and I was like my end of the year target is $5,500 but my strike date is November 6th.

[00:34:16] Cem

Yeah, very good.

[00:34:19] Marko

That’s where we are. I think that’s all that matters right now. Nothing else matters.

[00:34:23] Cem

I completely agree. This is the stat I want to throw at you. Niels and I have talked about this a little bit, but I want to highlight it because it fits exactly into what you’re saying here. If you highlight 1928 to 2020 election years, you look at the data set, everybody’s like, look, election years are so positive, you’ve got to be bullish on election years. It’s 11.5%. That sounds, yeah, that’s positive. That sounds great. It wins 83% of the time.

But then if you cut the data and you just take that ’64 to ’82 period that we were talking about, that inflationary period, and you look at those dates, in ’64, Johnson was up 16.5% that year for the election, in ’68, 11.1%. Nixon, 19%. Carter up 24%. Reagan 32%. Every single one was double-digit positive. The average return was 21%. And if you take just that period out, that whole dataset, do you know what the returns for election years are? Five percent.

I think it’s incredibly important. That populist period, populism, people voting, these are the periods where the fiscal spending gets kicked in. That’s really when it matters, and that’s what we’re in right now. It’s not just elections matter. Elections matter when populism is in charge, and I think that’s a critically important point.

The second add-on point to that which I think is incredibly interesting and important is if you take that same period, we know 1968 to ’92, what did markets do nominally? They went nowhere. Yet every single election year was double digits positive.

[00:36:11] Marko

That’s a great point. Wow.

[00:36:12] Cem

You have four election years in that data period, and all four of them together, 21% on average. What do you think happened the other 10 years? Well, simple math. It lost 9% per year nominally. Now, in real terms, it lost 17% per year, 16 years, because you had all that inflation during that time.

[00:36:35] Marko

That’s a really cool point.

[00:36:37] Cem

It’s an incredibly powerful dataset, particularly in the context of what you and I are talking about. The secular trend relative to what’s happening in an election year, and all that matters is elections this year. Anyway, I think that’s really critical.

[00:36:48] Niels

I’m going to cut in here because we’ve talked a lot about things from the US perspective. You’ve mentioned briefly something that’s very profound actually regarding Europe and the energy. I’m curious, if we just stay with the 10 years that you talked about, that you’re comfortable with, I’m kind of curious on your view as how will this new world looks from a European perspective, from a Chinese perspective? What are the things they’re going to be experiencing with the changes that you see coming perhaps from the way the US will behave?

[00:37:21] Marko

There are a lot of idiomatic expressions in the English language but I think in other languages too for how, when you’re on the bottom, that’s when the reversal happens. Like the Bible says, “The meek shall inherit the earth”. Necessity is the mother of invention, all those sayings. And I think that a lot of people in this industry read too much of garbage journalism quite frankly, and they also extrapolate linearly.

When you do that, you’re going to get yourself into trouble. I can’t tell you how many clients tried to short the Euro at parity in 2022, and I was like, Hmm, okay. It actually ended up being temporarily right because we went down about 5% from parity, but then there was a vicious rally in September of 2022 of European assets precisely when everyone was the doomiest and gloomiest about Europe.

I think that history is filled with examples of how necessity truly is the mother of all invention. In Europe’s case, I think the best thing that ever happened to Europe was the energy crisis of 2022. I think one of the best things that probably happened to Europe, of course it’s a human tragedy so I don’t want to sound glib, but Russian aggression on Ukraine certainly woke up Europe to geopolitical realities that they’re facing.

One of them is this multipolar world where they cannot just simply depend on the US constantly. It’s not even clear the US has their interest, the best interest of Europe at heart. US has its own interests, and so on and so on. So I think that these events that have happened over the last two years are moving Europe into a direction that is positive, and one of them is energy security.

We were told in 2022 that they couldn’t build import terminals in time. The Germans ended up building several of them in basically three months. It was supposed to take two years. They now have more import capacity than really necessity, and supply of LNG is coming online. It was always going to come alive by the way. A lot of folks just ignored that. That’s why the deindustrialization thesis makes no sense.

If you’re building factories, you’re building them for a decade. You’re not going to move a factory to the United States of America if two years from now your electricity bill is going to collapse. No, there is some anecdotal evidence that some manufacturing did move, but that was usually manufacturing that was using natural gas as a feedstock into the manufacturing process.

Everybody always tells me, but what about BASF? What about the fertilizer industry? I’m like, okay, you guys do know Europe does more than just make fertilizer. I don’t know. So that’s where I think it’s a really interesting outcome, where the second and third-order effects are much more interesting to me than the first-order effect. The second and third-order effects for Europe are that it will have energy security.

Within two years, Europe will be able to buy LNG on the spot and it will be such a buyer’s market that I predict a future where the Europeans are basically playing off LNG cargoes off of Russian piped natural gas. We’re basically telling Russia, we’re going to buy a little bit of spot from the pipe, we’re going to buy a little bit on spot from LNG tankers. So no more 10-year contracts. Oil linking piped natural gas deals, yeah, forget it. That’s Stone Age. We’re going to do whatever we want, whenever we want it.

On top of that, there is a push for more nuclear power. And here, I always hear this very American centric view; the Germans don’t want nuclear power. Who cares? Who That will be like saying Illinois doesn’t want nuclear power. Okay, so? Ohio does. Are we stupid here? The French are building nuclear power plants and they have more reactors coming online. They’ll just sell the electricity back to Germany. And in a world where there’s plenty LNG, these electricity prices will be perfectly fine.

So this whole notion that just because Germany doesn’t want nuclear power somehow Europe is screwed is I think very simplistic and it doesn’t make any sense. You can have territories that refuse to build nuclear power plants. If the neighbour is building nuclear power plants, you’re fine. So I think energy security is resolved. There’s a geopolitical reality.

I think the current German government has no chance of winning the next election. It’s pretty clear. You will have a far more geopolitically aware country with the next administration that will swing the pendulum in Germany towards a self-realization that World War Two was a long time ago and it’s time to have a foreign policy with some teeth and with some intentionality. So that’s going to happen.

You’re going to have more integration within Europe to create a geopolitical actor, not the same as US or China, but I’m very bullish on this direction. I think Europe is becoming aware of the threats around it and is building capacities to meet them. That’s good for European defense companies. That’s good for industrials domestically, and ultimately, it’s going to be good for electricity prices over the long term.

And look, the market has rewarded Europe. The DAX is at all-time highs despite the fact that the country is in a recession. I think some of this has to do with this overcorrection towards the bearishness in 2022. It was seen as like, well, Europe can’t sustain itself. So people often ask me, because I’m a dollar bear for a number of different reasons, not because the US is collapsing, the dollar goes through bear markets. It’s a macro view, it’s not a geopolitical view at all.

But they always ask me, where are you going to buy? Oh, I’ll buy in Europe. Absolutely. What happened in Ukraine is on the long-term viability of the euro. These debates are over. Nobody in Europe is debating whether they should leave the Euro anymore. Maybe some of the French groups, maybe AFD a little bit still in Germany, but most of the populist leaders in Europe, like populist, Euroskeptic in a traditional Gaullist sense, most of them have pretty much marked this as the end.

They don’t want to debate the Euro’s existence. They’re fine with it. They’re anti-immigration. They’re anti this. They’re procyclical fiscal policy. They’re populist, but euro’s viability is out, and I think that also gives assets domestically a little bit of a flow advantage as well. The fear of owning euros and then 10 years around them disappearing, I think that fear is dissipating. That existential risk is off the table for now.

[00:44:20] Niels

I agree with a lot of what you said here. Obviously, there’s certain things I have no clue about, about energy, future energy supplies and all of that stuff. But certainly, it has been a wakeup call for Europeans, and being based here in Europe, it’s very evident to see. It’s nice to hear an optimistic view on Europe. I don’t come across that so often because people are still very focused on the US being the only game in town.

I think actually there’s one of those weekly economists or something that has a feature out at the moment, a front page with a weightlifter in stars and stripes, and that’s kind of the strongest economy out there. But my point is that it kind of must be based on the fact that the conflict that we’re seeing will be contained to Ukraine. So I’m just curious, generally speaking, from a conflict point of view, geopolitical point of view, I know it’s been 43 minutes now where we haven’t talked about Ukraine in that sense, but I am curious, what happens with Ukraine?

[00:45:30] Marko

The first thing I just want to say is, you’re absolutely right. Everyone’s overweight the US. And one of the reasons I’m optimistic in Europe is because everyone is overweight the US. I have allocators come to my office. They run very large endowments of venture funds. They ask me questions like, why should I ever own an asset that’s not in the US?

That’s where we are today, where professional institutional investors that allocate hundreds of billions of dollars as their job don’t want to own a non-US asset. And so my argument here is not to say it’s the end of America at all. The US is clearly the most powerful country in the world. Multipolarity doesn’t mean the US is not number one. It just doesn’t have the preponderance of power.

But that’s not why I want to allocate outside the US just to be clear. Just to be clear, before I answer your question on Ukraine, I just want to say one very important thing. Too many people equate this to some sort of a geopolitical ordering. That’s so simplistic. It’s like almost insulting. When was the US underperforming last? It was from 2001 to 2009. That was your last CapEx cycle. That was Jim O’Neill and BRICS. That’s when you wanted to own emerging markets and commodities.

Well, when was the US in geopolitical power? It was probably the most powerful political entity in history of humanity. George W. Bush was throwing darts on a map and choosing where to invade. So the US was at a peak of geopolitical power, but its assets were underperforming. So that’s one thing that I want to say.

Yes, I’m definitely bullish Euro. I’m bullish Japan. I’m actually bullish emerging markets too. I think we’re entering a five-year period where US will underperform but it’s not a function of some American decline. It’s a function of the macro setup that I think we’re in.

Now, to answer your question, absolutely, if Russia starts invading the Baltics, you probably don’t want to be long Europe. I think that what we’ve seen over the last two years is that Russia is not willing to go all in. If you step back and really squint the decision from a 30,000-foot perspective, Russia clearly has an advantage in terms of material resources, but it doesn’t have an advantage in terms of his esprit decor and credibility quite frankly.

It’s not willing to commit itself to the Ukrainian conflict in a massive way. So it has constraints, and I think these constraints are domestic. We have polling in Russia, this is pro-Kremlin polling agencies, Hey, God bless them. They can be pro-Kremlin, I’m looking at the trend lines. And the trend lines in Russian public opinion are that the majority of Russians now does not want the conflict to go on. They want the government to wrap it up.

More importantly, a majority of Russians, and maybe this is where the pro-Kremlin bias in the polls comes through, but the majority believe they won, which is kind of like almost like thank God they think they won. Because it allows Putin to then slowly end the conflict, call up his buddy George W. Bush, see if the ‘mission accomplished’ banner is still available so they can reuse it in Russia, throw it up on the aircraft carrier that can barely float, and boom, they’re satisfied.

Now, there is part of Donetsk, the oblast of Donetsk, which I do believe they kind of have to conquer. It’s northwest of Avdiivka, the town that was recently conquered by the Russians. It’s kind of a sore thumb for the Russians. It’s part of Donbas that has not yet been conquered. So there’s about a third of Donetsk that still needs to be conquered I think for the Russians to truly be satisfied. But that’s it.

They haven’t tried to relaunch an offensive against the Kremlin, never take too much mobilization. I don’t see a domestic consensus for that or really political maneuverability for that to happen. So to answer your question, from the Russian behavior of the last two years, what we know is that if they are not willing to launch a new offensive in Ukraine to retake Kyiv, and I mean a really big offensive, how do they have the domestic political maneuvering room to do anything beyond it?

[00:49:51] Cem

I’m curious. Do you see Russia as a fully independent actor? II kind of look at it as almost like a vassal state of China at this point. They came out in early 2022 and announced in a very clear document like we are united against the West and x, y and z. And honestly, the Hamas act against Israel as well seemed like another front on the same wars. This to me almost seems like a bipolar conflict that is continuing down a more secular path.

I’d be curious, all this spoke from Russia and China I think, as tends to happen when these major conflicts happen due to a feeling of weakness, a feeling of being encircled and somehow at risk. I think that union was out of necessity as well. What happens the more they become encircled, the more that Europe is stronger now and it doesn’t have energy constraints and now can continue to encircle?

Does that increase the bigger risk of something much more global? It may mute the short-term war in Ukraine, but does it make the existential risk of a bigger global conflict, a hot war, more? I’m just being polemical here.

[00:51:27] Marko

I think if the world did become bipolar, you’re right. Well, first of all, we’d kind of be in an equilibrium but it would be a difficult one to maintain because Russia and China, if they were united as a poll, they would stand no chance against the West. Really, like there’s just zero chance. It would be a very poor alliance.

Japan, South Korea, Taiwan, Australia, New Zealand, Canada, the EU and the United States of America are just overwhelmingly powerful technologically, economically, materially. From a resource perspective, it’s not a contest. We’re not fighting trench warfare is anymore. So China has people, great. Increasingly aging people too.

So I think that a bipolar distribution of power would serve American interests. That is why what you have just said is sort of what Americans have been trying to argue to the Europeans, to the Japanese, to the Indians. Like, hey, Russia and China are allies, you guys need to be on our side and we need to create this containment structure around China that we had around the Soviet Union.

The reason that I think you’re wrong and the reason that the American foreign policy propaganda has not worked is that the rest of the world just doesn’t see it that way. I think the rest of the world is kind of right objectively. China and Russia and not really allies. Think about it.

Russia needs a lot of help. Over the last two years, they’ve had munition supply problems, they’ve had shortages. China is a weird, strange ally. It hasn’t really given them any military help. And believe me, the Americans are watching carefully. If there was evidence that China was sending military equipment to the Russians, US would have found it.

In fact, there was that case where the US did find that there were some drones being sent to Russia and it ended up being some college student that started a drone company in like either Mongolia sending drones to Russia unbeknownst to the fact that Beijing didn’t want him to do that. That guy has not been heard of. I’m joking actually. I don’t know what happened to him so don’t quote me on that.

But the point is that the Chinese have maintained an arms embargo on Russia. There is some seepage sure through Central Asia, but there’s seepage through Dubai, there’s seepage through EU countries, so let’s not make a big deal out of it. So that endless friendship agreement you’re talking about, that Xi and Putin agreed to ahead of the invasion, I got to say, China is a weird BFF to Russia.

It hasn’t really done what you would expect an ally to do other than buying their oil, which again, Indians are doing, and they’re supposedly allied with the US against China. So I would say that the bipolar ordering is just not happening. The big wedge player, really critical player in all of this is Europe. The Chinese don’t want to alienate Europe. That’s why they’ve pulled the very controversial ambassador to France who was kind of the tip of the spear in terms of wolf warrior diplomacy.

He’s been pulled and recalled back to China. They’ve tried to massage the rhetoric and have tried to improve the relationship because Europe remaining an independent actor is a very important factor to the global multipolarity. If Europe was just blindly following the US on this, then yes, I think we would be in the world that you’re describing, but we’re just not.

And then you have other actors like Saudi Arabia, India, Indonesia, South Africa, Brazil, countries around the global South are increasingly becoming aware that neither China nor the US are as powerful as their counterparts during the Cold War, the US and the Soviet Union. And so actually, it pays to be geopolitically promiscuous and flip and flop between the two because you end up being showered with money by both superpowers.

It’s almost like children of divorced parents. You get two Christmases, you get two birthdays from mom and dad, and that’s what’s happening as well. And so just from the behavior of states, I think that it’s pretty clear that the world is more multipolar than bipolar. But what you were saying is definitely something the US is trying to create, very hard at working, very hard at trying to create a very clear bipolar structure because it would solve all of America’s problems.

If you could convince Europe and Japan and South Korea and India that look, you’ve got to pick one or the other camp, if you could convince the rest of the world that this is the reality, it will be kind of game over for Russia and China at that point.

[00:56:16] Cem

The US, there are incentives across the board. And you had up until two years ago a very ascended China. The conversation around China, speaking about narratives and how they come and go, is so different than it was just two or three years ago. There are books after books written by well-known people who I won’t name about how China was on the verge of overtaking the West. Now we’re talking about there’s no chance, China is this dying power.

I work with several Chinese nationals and I understand the culture. They still do have a great pride and belief that they are the next superpower. So I would push back a little bit, I think it’s not just a US narrative it is. I think the alliance that came before the invasion of Russia to Ukraine was one that was, to a great extent, because China has a commodity issue.

They have this true weakness that they are aware of and that the only way they can secure that was through an alliance with Russia. I do think China has, and I could be wrong about this one, I’d love to hear your thoughts, but does have long-term aspirations of breaking that first island chain and all the other things, almost will need to, its necessitated if they truly want to be the world’s next superpower, which I believe they still have great aspirations of.

[00:57:58] Marko

But so does every other country. Absolutely, but it just doesn’t make it so. I was never in a camp that China would overtake the US or become the next hegemon. And now I’m not in a camp that it’s going to collapse. It’s just a great power. It’s import of Russian oil has, in delta terms, in rate of change terms, actually, India is bathing in Russian oil. So their alliance with Russia has not led to a massive surge in Russia imports of oil.

Really, they’ve been importing ever more from the Middle East. And that’s very funny in a way because China has become a factor of stability in the Middle East and kind of shares the same interest as the US as far as the Middle East is concerned. It wants a stable equilibrium in the region. But to the point about, look, of course, China wants to have good relationship with Russia and of course it’s based in commodities.

But again, empirically speaking over the last few years, China has not been willing to do what you would assume a true best friends forever would do. They haven’t sent military technology to Russia that Russia solely needed, and they have equivocated in their support to Russia. They have. They’ve actually argued that Ukrainian sovereignty has been violated. We just don’t talk about that in our own narratives here domestically because it doesn’t fit it.

So they’ve said America is to blame for Russian invasion of Ukraine. They’ve said that this is America’s fault, but we also want to respect Ukraine’s sovereignty, which usually we take out in our reporting of what the Chinese are saying. So I guess they have just a little bit more complicated maybe view. It’s difficult to really pin down their relationship with Russia.

They want to maintain a very strong relationship with the rest of the world too, particularly in the Middle East, the Global South, and Europe as well, because they want to drive a wedge between US and Europe. I think that’s the critical thing the Chinese are trying to do and I think that’s why they’ve stayed back from supporting Russia 100%.

They want to be able to rely on Europe as a source of Western technology for the next 5, 10 years, and that’s why they don’t want to commit fully 100% to Russia as a military ally. But that doesn’t mean that they don’t have aspirations. I agree with you of course. Yeah, they want to be a global power for sure.

[01:00:29] Cem

That’s interesting. I don’t see them even believing they can separate Europe from the US, but they are definitely trying. I think what they’re currently doing is trying to separate Saudi, Turkey, other countries in the Middle East from, and I think that’s what the act in Israel by Hamas was about, an Iran, Russia, China group trying to, right before Saudi and Israel obviously signed that pact, coming in and trying to drive a wedge right and peel off that part as much as they can against the current West. But again, who knows? This is all speculation.

[01:01:06] Marko

Think about, like for example, when the French president Macron went to Beijing. He took 40 very prominent CEOs of French industrial companies and just French companies to China. This happened last year. There’s this view in China that we still don’t have the technology we have and so we need to have commercial relations with Europe.

We’re not going to be geopolitical allies with it, but let’s have a better commercial relationship than the US. And that’s where the true multipolarity of the world comes to fruition and it becomes very much aware for everyone to see. During the Cold War, there was no way that France would have been selling wide body aircraft to the Soviet Union. That just would not have happened.

In a true bipolar world, the US president picks up the phone and tells the French president like, what are you doing? You’re not going with four CEOs to Beijing. In a more nuanced world, where these relationships are more fluid and promiscuous, that’s what’s happening. So yeah, that’s where we have to be less rigid about thinking of the world as divided into clear alliances. Because you’re right, China and Europe will not be strategic allies, but their relationship can be much better than it should be in a truly bipolar world, and that creates these wedges.

[01:02:29] Cem

To be clear, I’m not saying the whole thing is a bipolar world. But when there are two significant powers and their acts, at some point, think World War Two, at some point, things do come down to power. That’s just the reality. But incredibly insightful thoughts and conversation.

One last question before Niels wraps us up here with what he has to say. Does China invade Taiwan in the next five years or do something at least that amounts to that?

[01:03:02] Marko

No, I think in the next five years, no. I think one of the reasons is they themselves have been rattled domestically. I think they definitely have long-term aspirations to become the next global power. But domestically, I think there is this sense that what’s needed is a revival of the domestic economy.

That’s going to take some time because I think China is in the middle of a secular stagnation. They’re simply 10 years behind us on everything. And so they’re kind of in the middle of their private sector deleveraging, which will take a long time. During that period, quite frankly, China becomes more dependent on external sources of demand. So that is a big constraint to them, this economic situation, the macro context.

They really need external demand more than domestic because domestic demand is going to continue to suffer. The second issue is that they’ve been watching Russia invade Ukraine and they’ve been learning. They’ve been learning about Western response, they’ve been learning about civil society response, which I think shook the Chinese more than anything else, just this cancellation of Russia, corporates moving out of Russia without any government interference.

It’s not like the White House was out there calling Coca-Cola and McDonald’s, hey, get out of Russia. I think the Chinese are watching that carefully. That would really affect them much more than it affected the Russian economy. And then finally, I think they have time. There isn’t a clock. I think it’s partly American propaganda, quite frankly, that there is a clock for invading Taiwan. We hear about how Xi Jinping has to do it. He doesn’t.

The reason I say that is because the Chinese Communist Party has continued to rule China without having resolved the Taiwan issue. In other words, they can maintain legitimacy as a ruler of China without resolving this problem, without bringing in the wayward province of Taiwan back into the fold. The question that Chinese policymakers have is can we continue to be legitimate rulers of China if the economy completely collapses, if the entire world reorients and says you guys are bad, boom tariffs, boom protectionism?

At that point, that’s a much bigger risk than not conquering Taiwan. So the risk/reward, at least for the next five years, is clearly flashing red and I don’t think Beijing is going to make a mistake by invading Taiwan.

[01:05:30] Niels

Marko, this was great. I’m not going to pose my last topic. I think we should end with this one. Then we have something to start with next time we speak to you. This was a tremendous conversation and a lot of knowledge and experience of course that we’re grateful for you sharing today.

To all our listeners, make sure you follow and subscribe to Marko’s work. As you can tell from today’s conversation, we are truly living in a global macro driven world and it is perhaps more important than ever before to stay well informed.

From Cem and me, thanks so much for listening. We look forward to being back with you as we continue our Global Macro series. In the meantime, take care of yourself and take care of each other.

[01:06:14] Ending

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