Originally sent to VIXCONTANGO subscribers on August 28th, 2019
Geo-Economics and The 3 Continental Cartels
The study of geoeconomics is a branch of geopolitics that deals with the political aspects of economies. The same logic that leads to military conflict pertains to international commerce. States (or groups of states) seek to collect as much tax revenue as they can from their domain while at the same time blocking other states (or groups of states) from doing so. This is a zero-sum game that inherently invites conflict. States regulate economic activity to maximize their own welfare instead of global welfare and since other states suffer that again invites conflict. States seek to restrict payouts and benefits to their own residents at the expense of global welfare. States promote technology innovation to benefit them not for the sake of innovation itself. Geoeconomics is often confused with mercantilism whose goal is to maximize national gold stocks which historically has led to military conflicts. However, mercantilism is subordinate to geopolitics and military competition. In the new era of geoeconomics, military warfare takes a back seat to economic warfare. Diplomatic and military conflicts are resolved with the weapons of commerce. At the end of the Cold War, Richard Nixon said that geoeconomics will supercede geopolitics. The next war will be won with microchips and trade deals not swords.
What are the weapons of geoeconomics? R&D credits, tax cuts on domestic production, tax hikes on foreign production, tariffs, regulatory curbs for foreign companies, export financing, collection of technology intelligence, industry subsidies, state owned enterprises, predatory finance, currency depreciation, below market interest rates, free trade blocs, etc.
By now you should recognize that US and China are in a major geoeconomic conflict. But they are not the only competitors on the stage. The European Union is also trying to establish itself as a Tier 1 force and trying to compete. As I see it, there are three Tier 1 geoeconomic cartels today: United States, China and the European Union. The US is currently trying to get a couple of major additions to its coalition with Japan and United Kingdom by signing free-trade pacts with them. The US is trying to steal the UK from Europe and establish an outpost there. The Japanese outpost for Cartel America in Asia is a given. China has North Korea, Iran and other parts of Asia in its Cartel Asia. It is currently trying to add Russia. Cartel Europe has Germany, France, etc, Western Europe and Eastern Europe. Europe also is trying to add Russia to its cartel. There are two 2nd Tier geoeconomic powers – Russia and India – whose place is currently somewhat uncertain. They are free agents. Which coalition will they join? India by many indications will be the world’s primary generator of economic growth over the next 20 years so India will rightfully might to turn into a Tier 1 power instead of joining an existing cartel. But we will see if they are capable of that. I think the European Union is making a major mistake by letting Russia team up with China over Crimea. It is the height of stupidity to lose such a large economic and military ally. Brazil is also an emerging geopolitical power, but I think the US will seek to add Brazil to its Cartel America together with the rest of South America.
By now you are probably thinking – what the hell are you talking about? Don’t you know about the US led global order? Well, here is the reality. The post WW2 US led global order is dead. It never had a chance in the long run. The last 30 years are moment in history soon to be forgotten. Why is that? When people think of economic or computer systems people either think either a centralized system or a distributed system. Either a system with one dominant player or a multitude of small players with limited resources. In reality, whether with computers or economics, there is power in unity. Economic regions when combined are more powerful together via the forces of specialization than when they are apart. They also have access to more resources whether human capital, earth resources or production capabilities. Competition itself breeds unification. Why? Because a winner takes all and when faced with a bigger competitor, smaller players gang up to form their own big competitor that can survive. It is better to have a share of your own coalition that can reach parity with a big competitor and survive or even expand your economic interest than to lose all in direct competition with a bigger competitor. So while systems may start as highly fragmented or centralized, they always tend to end up in a state of oligopoly. A few dominant cartels (union of smaller players) which have a lot of resources. There was no Italy in 1850. There was Florence, Milan, Rome, Naples. But France was big and unified and they would raid Florence, Milan and Rome every year. Heck, France owned Naples. Apart Florence, Milan, Rome and Naples didn’t have the power to confront France. But in a cartel, they did. And so Garibaldi created Italy – a cartel of city states. Apart the European Union countries such as Spain and Italy can’t compete with the US or China, but together they can. Federalization/cartelization is simply inevitable and won’t stop. Despite the constant cries of the death of the European Union, it will only become a bigger and more entrenched reality.
However, unification has practical limits. Economic or computer system never end up with just one system. One use case doesn’t serve everybody equally. There never will be one currency or one dominant economic cartel. Simply because there are losers and winners and the losers will always gang up to compete with the winner. It is inevitable. The concept of a single world currency like the dollar or bitcoin was doomed from the start. The concept of a US led global order forever was doomed from the start. The more resilient long term form of system organization is oligopoly – whether in business or politics or geoeconomics, oligopoly is where all systems end up. 3-4 competitors of equal size who have the resources and capability of annihilating their competitors completely and thus are too scared to fight directly. Peace through strength. For every Oracle database, you will have SQL Server database. For every Walmart, you will get an Amazon. For every United States, you will get China (or a Soviet Union). For every Republican Party, you will get Democratic Party.
The world is not a G7 or G20. The world was a G2 (US/West Europe and USSR/Eastern Europe) and the world has now moved to a G3 – US, China and Europe.
There is a school of thought that keeps thinking of Europe as part of the US cartel. Why doesn’t the US just gang up with Europe and go after China? That’s what most of the US establishment thinks is the best course. But that ignores what Europeans think. The problem is that Europe is suffering from the United States. The US has a superior federalized economic and governance system that is about 300 years ahead of Europe’s own. Heck, the European Monetary Union was only formed 20 years ago. The US sucks the best and brightest out of Europe generation after generation. It has been many decades now and Europe is starting to recognize that it is losing tax revenue and benefits with this constant brain drain to the US. So at some point they will act in their self-interest and try to stop this migration. US tech companies are obliterating European industries and thus tax revenues and benefits available to European residents are not going to be available. Europe is going to try to stop that. Europe sees how effective China has been in fostering its own tech industry by blocking off Google and Facebook. The only reason why Europe doesn’t have Google and Facebook equivalents is because they let Google and Facebook run roughshod over nascent European competition. Russia which regulated Google has its own viable search engine. That is why Europe is creating its own European Future Fund and seeding with $100 billion to foster tech companies in Europe. That is why European regulation on Google and Facebook is coming and coming in hard. The competition for tax revenue and payouts to residents is what is going to drive Europe to define its own cartel which from a wealth and population perspective is equivalent to the US. Why should Europe just give itself away for free to the US? Not going to happen. So I see Europe not only becoming a more active and independent geoeconomic player on the international stage but I think they will develop their own army and enter the geopolitical sphere. I personally view these G7 meetings as a bit of a farce – France and Spain and Germany don’t belong on the same table with the US or Japan. France, Spain and Germany together belong on the same table, but not apart.
As US share of world GDP declines and the world ex US grows faster than the US, the US Dollar can’t keep the reserve currency status it acquired in WW2. Supply of dollars simply can’t keep up with world growth (in real terms). I mean you can print dollars all you want but that’s not the point, the point is “real” dollars backed by GDP output. And neither does it have enough money to pay everybody else off and keep them in a “one world” global coalition. The world inevitably will break down into the 3 dominant blocs we see today and those blocs over time will become more independent, more self-sufficient and more powerful. At the end of the day, I see 3 major international players as better than 2 anyway. There is a lot of stupidity between two competitors. A 3rd player brings an element of sanity to the room. Europe is needed to keep the US and China competition from going insane.
The Era of Globalization is over. Now we are in the Era of Cartelization and the Three Continental Cartels.
When it comes to your investments, realize that “cartelization” will likely result in smaller world markets for the companies you invest than currently envisioned. Tech company profits in Europe will not go untaxed and moreover will be subject to regulatory destruction in favor of domestic European competitors. While you probably have 3 major free trade blocs, commerce barriers between the Three Continental Cartels will be substantial and will involve every weapon of geopolitical warfare you can think off. And the Continents will not be backing down from this. This is a reality that you need to keep in mind as you look at your investments going forward and look to size up their potential. Big $SPX tech companies will end up with 1/3 of their originally envisioned market – China and Europe won’t be part of it. Thus the high growth multiple that they have been given by investors over time will dwindle. Investing in smaller players that have room to grow within their continent is probably going to be a better strategy than investing in huge players who are going to struggle to grow with the continental barriers being put in place today. Finally, world resources aren’t likely to be shared. Cartelization of resources will lead to higher commodity prices. Imagine if the US didn’t have access to Russian and Chinese silver mines and is only left with Mexican output? What will happen to the price of silver? We are used to all commodity markets being priced in dollars on a global market but going forward I see a separate commodity markets in each continent. China will have its own oil and gold markets. Europe will have its own and the US will have its own. Each cartel will have fully functioning independent market systems. And each continental cartel will have its own continental currency, of course – the US dollar, the Euro and the Yuan.
In terms of what becomes the next reserve currency, the Chinese Cartel doesn’t have the maturity, marketplaces and GDP product to be at par with the US and Europe yet. Just take a look at the SDR – the power relationships are perfectly expressed there. You have the Cartel America with 60% share, Cartel Europe with 30% and Cartel Asia with 10%. That is exactly where we are today. In which bloc Russia and India end up is the next question that can materially change these weights or China upping its game dramatically with Africa which I don’t foresee. At some point Africa will become a geo-economic consideration as well. If Europe can somehow attract Russia and India into its orbit, it can get its share up to 35%, but can Europe execute on that? With Lagarde as ECB head, Europe is off to a good start!