Geo-political Analysis

Report No. 32 | 17 October 2014

AUTUMN BRINGS COLD TURKEY

An independent analysis of the international

geo-political scene by John Longhurst

The Bottom-line:

As summer fades into the rear view mirror north of the Equator, 2014 has thus far been a game of

chicken; Central Bankers with markets, Putin with The West, IS(IL) with ‘everyone’, Iran with P5+1.

Last week’s theatre of an embittered old billionaire, Hank Greenberg, suing the US government for

having the courage to bail out AIG in the Winter of ‘08, had Ben Bernanke and Tim Geitner on the

stand.

Autumn 2008 is now six years ago – six years! And yet, for most Western citizens, the Global Financial

Crisis was in fact just beginning. With the US now ending its ‘QE’ programme (ie emergency money

printing drugs to prop up the economy – outdone only by China’s QE), and Europe/China/Japan

not stepping in to fill the void, global financial markets have already started suffering withdrawal

symptoms.

Volatile financial markets, going up against frothy global asset bubbles (eg property, art), and set

against six years of real wage declines for 700m Western citizens and the collapse of the Western

Middle Class, suggests optimistic expectations for global growth in 2015 remain just that – optimistic.

From 2009-13, we were positive overall about the global recovery in a cyclical context, and have

not seen geo-politics being a meaningful headwind to this. We now see ‘cyclical stagnation’

coupled with secular and geo-political headwinds. Thanksgiving 2014 will be one of Cold Turkey.

2015 is shaping up to be Rotten Eggs.

Autumn Chill

With the US now the global ‘swing’ oil producer, and with the oil price already down 25% since

June (so too for China-linked commodities like iron ore), ‘commodity economies’ throughout

the Mid-East, Latin America and Russia, face a very tough 2015. Europe and Japan are both

flirting with recession, again. November is a big month too for the US and Iran. The former has

mid-term elections that will remind us that as the US middle-class collapses, the plutocracy and

their self-serving whims increasingly call the shots in Congress – much like the English Parliament

of the 1700’s.

On Iranian nuclear talks, we see them again being kicked into the long-grass, and November’s

deadline will pass with little noise. Neither President Obama nor Rouhani can carry a deal at

present. For Obama, the Israel lobby has won the debate for now, and holds the financial keys

to most Congressional battles. For Rouhani, Khamenei will never sign away nuclear weapon

optionality.

However, neither Rouhani nor President Obama wants to close the door; Obama needs one

foreign policy success for his legacy, to book-end with his healthcare reform at home, so we

see him trying to close a deal in 2015. Rouhani has won favour for his domestic policies but

wants to begin the process of reconnecting Iran with the global economy. Meantime, Israel’s

recent stealth bombing of Iran’s controversial Parchin facility (barely reported, despite French

satellite confirmation of an air attack), sets back Iran’s covert nuclear weapons programme

(again).

WHAT IS GETTING OUR ATTENTION?

IS(IL) How not to run a coalition:

The hastily gathered coalition to conduct air strikes in Iraq and Syria is unravelling almost as

quickly, and the axiom of boots on the ground is again being demonstrated by IS successes

in winning and holding new towns in Sunni tribal areas. The new leadership in Baghdad has

yet to formulate a new government and in the void, IS remains potent.

In a sense, the case for US boots on the ground is more compelling in Iraq than Syria, but

rightly we think, President Obama wants to avoid his own Vietnam. As with Ukraine, the

whole situation would be far simpler if the men in smoke filled rooms at Langley and MI6, had

left Assad alone; the asymmetry between the upside/downside has been laid bare by IS.

Turkey is pushing for a no fly zone over Syria from the US before it will commit forces or allow

Turkish NATO bases to be used by the coalition against IS. We do not see IS being

extinguished any time soon. In order to save Iraqi oil and water assets, we believe the US will

indeed commit more 'advisers' in due course, and all key parties (Saudi, Iran, US) will push for

an inclusive Baghdad leadership as the start of a long process of bringing disaffected Sunni's

back into 'Iraq'. We also see President Obama's successor inheriting the mess.

The key question is if IS can be 'contained' in Anbar and West Syria, will it also serve to

legitimise IS control in those areas, leading to the change in the map the Caliph laid out?

Global GDP matters:

At a time when global threats are rising steadily, the demands on armed forces are causing

headaches across Europe and the US. As we laid out in our last GPS report, "Putin's shrinking

Manhood", commodity economies will feel this particularly sharply. With oil heading below

$80/barrel, and others commodities in free fall, the Middle East, Russia, Australia, Brazil and

others will see a sharp reduction in Income in 2015.

Ironically, because The West has weened itself away from energy intensity, falling oil prices

do not provide sufficient tailwind to consumers in these net using countries, to boost global

GDP. Right now, wage deflation and rising taxes outweigh lower commodity prices. With the

US as the global swing oil producer right now, we see various expediencies impeding a major

effort to curb lower energy prices. We see serious cracks in not only Russia, but Brazil,

Mexico, Venezuela and others.

Most forecasters still see global GDP growth in 2015 of 3.5-4%; we see nearer 2%, with

deflation in West Europe, and recession in Russia, Latin America and the Mid East.

We can expect ever increasing shrill noises from G20 and IMF meetings. Why leaders in the US

and Europe refuse simple 'wins' like borrowing to invest in infrastructure remains one of the

great mysteries of our time.

What can be done?

Every country with a growth issue will use different tools. If Brazil gets a new a President,

massive state projects will be cut back and more competition fostered, as well as a weaker

currency. For Japan, aside from more QE (to weaken the currency), labour market reform

and corporate tax cuts will be needed. In Mexico, reform of monopolies will continue and

opening of industry to foreign investment will be sped up, especially in energy. In Europe,

Draghi's hand is being called. Without outright QE in 2015, Europe will have deflation and

recession.

In the US, our view has been that Yellen will only revert to QE if real economic dislocation

occurs. We suspect she will make clear during 2015 that the Fed cannot solve all America's ills

via interest rates and money printing, and that Congress will need to calm its endless warfare

to make decisions that will aid economic activity. It may take a few quarters of near-

recession to convince them that constituents' economic interests (rather than plutocrats),

need urgent attention.

US mid-terms

Republicans are feeling increasingly confident that they will hold The House and take The

Senate. This leaves a fairly simple final two years of the Obama Presidency. He will propose

very little for the domestic agenda, save for tax reform (eg inversions), and electoral reform

(anti gerrymandering). Outcomes are unlikely until the next President, same too immigration

reform (and reviving America's economic dynamism).

We do see more money for Defence spending to avoid the effects of Sequestration and to fund

this, the Republicans will agree to Democratic wishes to raise the debt ceiling. We will write

separately about the US defence budget after the mid-terms.

Ebola

We have no insight on the matter but highlight two things. One, with most economies flirting

with recession, fear of travel could not be worse timed. Confidence needs to be restored very

quickly. Second, Ebola has an 8-20 day incubation period. This is not good news. We would

highlight European entry points from Africa and in particular France and Italy, as potential flash

points in the coming weeks.

Biography – John Longhurst

John spent 28 years as an investment analyst and fund manager, with a focus on global

defence/aerospace industries, interactive media and industrial as well as broader cyber and

geopolitical areas. Starting with James Capel in 1986, John attained a No.1 ranking aged 21

and was the youngest ever top ranked analyst in competitive polls from 1988 until 1996,

when he joined Capital Group Companies of Los Angeles, one of the world's leading fund

management companies, managing more than $1tn of client assets.

After becoming a senior Shareholder at Capital Group, he moved to PIMCO in 2011, as Head

of Emerging Markets equity research, and PIMCO's first Equity Research Director. PIMCO is

one of the world's top-5 global fund managers by assets, managing more than $2tn of client

assets.

John was voted by Defence News as one of the 100 most influential people in the US

Defence Establishment, and maintains a global defence and cyber network. He has been

actively involved in start-up companies over the past decade, acting as CEO or Executive

Chairman in an unpaid capacity. He is now based in Tallinn as an independent geopolitical

and market analyst.