IS, TPP, South China Sea: The 2016 Geopolitical Outlook by Bill O’Grady of Confluence Investment Management
(This is our last issue of 2015. Our next issue will be published Jan. 11, 2016.)

As is our custom, we close out the current year with our outlook for the next one. This report is less a series of predictions as it is a list of potential geopolitical issues that we believe will dominate the international landscape in the upcoming year. It is not designed to be exhaustive; instead, it focuses on the “big picture” conditions that we believe will affect policy and markets going forward. They are listed in order of importance.

Issue #1: The Election Transition

During the Cold War, transitions of power between U.S. administrations were generally stable and consistent in terms of foreign policy. That’s because each government had to deal with containing the Soviet Union. Clearly, there were differences between Presidents Carter and Reagan in their approaches to foreign policy, but the focus was always the same.

In the post-Cold War environment, American foreign policy has been adrift. This is because there has been no singular focus for policy. Because of this lack of focus, foreign policy has to be created anew by each new administration and, to a great extent, has simply become a reaction against the policies of its predecessor.

This lack of continuity has caused a myriad of problems. Allies cannot count on consistent policies; enemies hope that new policies from the next administration will be more favorable. It becomes almost impossible to plan for external security; for example, allied military leaders never know for sure what the focus of the new administration will be. For example, will the emphasis be on asymmetric warfare, on conventional defense, or something else?
The U.S. has been gifted with substantial natural and created defenses in the form of two large oceans and secure borders, and as such we can indulge in policy volatility. Other nations tend to bear the brunt of our lack of consistency. Until the U.S. decides on a foreign policy priority, policy variance will continue.

What does this mean for next year? Every presidential candidate is offering a different foreign policy than President Obama. This includes those running from his own party. There is widespread dissatisfaction with Obama’s foreign policy, therefore it is natural for candidates to offer different policies to exploit this discontent.

Thus, one would expect that foreign leaders presume a reversal of current U.S. policy once the new president takes the oath of office. If a Republican wins (assuming it isn’t Rand Paul), policy could become rather belligerent. Even a return to neo-conservative policies could occur. Hillary Clinton has generally been critical of President Obama’s policies as well.

Nations that tend to have difficult relations with the U.S., such as Russia, Iran and China, will likely view 2016 as a closing window of opportunity to expand power and influence. Nations friendly with the U.S., such as Israel, Saudi Arabia, the Eurozone and the Pacific Rim democracies, will see this as a year to fend off aggression from the aforementioned “difficult” nations. Thus, we would expect geopolitical volatility to increase in 2016 in anticipation of a change in the White House.

Issue #2: TPP and Western Populism

Across the West, middle class households are being buffeted by a myriad of adverse circumstances. Incomes have stagnated. The combination of technology and globalization has led to persistently slow wage growth. For much of the past three decades, households have offset declining wages by increasing debt. The 2008 financial crisis ended that mechanism for maintaining consumption. Meanwhile, households with workers able to manage new technology and compete in a global environment have seen their economic lot improve dramatically over the past 35 years, leading to greater income inequality.

At the same time, social structures are changing as well. In Europe, the refugee situation has exacerbated the problems many nations face in assimilating existing immigrants. In the U.S., there is rising opposition to immigration, with a strong focus on undocumented aliens. As income growth has slowed, tensions are rising between various ethnic groups.

As we will discuss below, citizens of the West also face threats from terrorism. Across Europe and the U.S., there is great fear of a rise of “lone wolf” attackers that are nearly impossible to stop in advance.

Simply put, the Western middle class feels beset by both internal and external threats that give them a feeling their world is out of control. Additionally, the political establishment seems detached from the travails they face. In fact, the elites, who benefit from globalization and automation and generally support immigration to keep wage costs low (the establishment also tends to own capital or directly services those who do), are inclined to dismiss the worries of the middle class.

The populists are revolting. In the U.S., populist candidates are primarily represented by Donald Trump and Sen. Bernie Sanders, but several other GOP candidates are either in this mode or are trying to convince voters that they are populists as well. Ben Carson and Sen. Ted Cruz are pushing their populist credentials.1 The rise of populism isn’t limited to just the U.S. Across Europe, populist parties are gaining influence. Earlier this month, the National Front party in France scored major gains in regional elections. Both leftist and rightest anti-establishment parties have emerged in Greece. In Denmark, the Danish People’s Party is a right-wing populist party, as is the True Finns Party in Finland. In Spain, Podemos is a left-wing populist party. In the U.K., the Independent Party has become increasingly popular.

What do these parties have in common?

They are nationalistic: This is especially true of right-wing populist parties, but even left-wing populists tend to focus more on domestic than foreign issues. Right-wing populists in America tend to be Jacksonians2; this position eschews nuance. For example, in dealing with Islamic State (IS), one often hears comments such as “bomb them into oblivion.” Destroying IS is meaningless unless one deals with the aftermath—what replaces IS? Do you restore the Sykes-Picot borders? What do you do with Syrian President Assad? Jacksonians like to win unconditionally and come home. Multinationalism is also generally opposed, meaning that the U.N. is considered, at best, ineffectual and, at worst, a tool to undermine U.S. sovereignty.

In Europe, the populist parties oppose the EU and the Eurozone. They tend to see Brussels as intrusive and undermining national sovereignty. They want border controls restored, and generally want to see the end of the euro project and the return of legacy currencies. They see the EU political establishment as detrimental to the goals and aspirations of the average European.

They are anti-immigrant: In general, populists from both the U.S. and Europe tend to be xenophobic, especially on the right. From an economic perspective, they view immigrants as competing for the jobs they currently hold (or used to hold). Socially, they view immigrants as representing an alien culture that threatens the established society. This condition is especially true in Europe but also exists in the U.S. to a lesser degree.

TPP  – What do the populists want? From an economic standpoint, they want to reverse the policies of globalization and deregulation. Import competition and automation have undermined the economic prospects for the middle class. Consequently, they want

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