We met with Geopolitical Strategist Peter Zeihan for a quarterly update right before the French presidential elections. In addition to calling Macron’s win, Peter outlined the three most important geopolitical shifts for US financial advisors to watch in the coming months. In order of priority:
- What’s next for Brexit? This is important because the UK’s moves are the most public and also the most likely to nudge talks on the European Union one way or another.
- This fall, China will choose its future leaders. It’s time to really start watching the leadership transition in China because this will be the main driver of Xi’s policy: everything else is a subset.
- The U.S. and President Trump: We’re all guessing at this point, and the president is involved in both of the above topics.
We’ve split the interview into two parts. Today we share part 1, our Q&A with Peter on recent developments in Europe and what’s next for Brexit and the European Union. Next week in part 2, we’ll cover China, North Korea and the United States. Recent moves by President Trump on each of these topics appear in both.
KLC: So Macron wins in France, what does it mean for Europe?
Peter Zeihan: I said about six months ago that I wasn’t worried about France. We take two big lessons from the French election so far. The center left and the center right are gone as leading lights. You still have the bureaucratic inertia, and that’s not insignificant in a statist system like France, but they don’t capture people’s imagination, and they’re probably not going to capture the presidency. With Macron, the presidency is now going to be owned by the outsiders: we’ll get a different sort of French government for at least one term. This French leadership will see the European Union as more than just a platform to project French power. Now, Macron is 39. He’s never held an elected office before. There’s so much that’s unknown, but judging from the sort of people who voted for him, the areas that voted for him, it’s really interesting. With all the nationalism and the populism that’s going on in the Western world right now, to think that it could be France that would be the one place that might push back, however temporarily, against that trend. I did not see that coming. It’s wonderful. It won’t last, but it’s wonderful.
It won’t last because France struggles with a similar set of issues that got Trump elected in the US –income inequality, immigration, loss of manufacturing –and you add on top of that this European malaise that we’ve now had since 2006. Never forget that their financial crisis actually started a year and a half before ours did in the US, and theirs is still going on. So they have had subpar, by European standards, growth now for almost half a generation. That’s got to wear on you.
KLC: Do you see the European Central Bank (ECB) using this as the backdrop to start making whispers about pulling back quantitative easing?
Peter Zeihan: They don’t have a choice. It takes a constitutional change if they’re to continue QE. The ECB can only buy a certain percentage of bonds of each country, and whenever they do QE, they have to buy bond proportionally to the economic size of the country, and the Germans are cutting their budget deficit. There isn’t enough German debt to continue QE, so QE has to end. I don’t mean to suggest that there’s nothing constructive that the ECB can do, but if you look at the real weak points in the European system, its state debt and the banks–QE no longer helps either of those. So Germany is cutting its budget deficit, which indirectly reduces fiscal stimulus for everyone. There are fewer bonds out there to be purchased. The ECB is using that as a catalyst, to throttle back on monetary stimulus.
KLC: But isn’t that a real double barrel hit for Europe? Unless their currency goes through the roof, Germany cutting back its budget deficit won’t help consumption in Europe. Won’t that exacerbate Spanish exports, Italian exports, everybody that exports to Germany?
Peter Zeihan: Well, they don’t want to stop, and I don’t blame them.The Germans aren’t worried about the trade deficit. I guess that’s one thing the Europeans have going for them. And it’s an election year in Germany, and unique among the Western world, balancing the budget in Germany is a vote winner. Remember, the German population demographically is so old that you have to do something pretty dramatic if you want them to increase consumption. And so I don’t expect much of a net change in that regard.
KLC: Your point about cutting the budget deficit is interesting, because the narrative we keep reading is everybody pounding on Germany to increase their fiscal stimulus.
Peter Zeihan: Oh, sure. People have been pounding on that since 2007, and the Germans have always said no. I’m kind of with the Germans on this one. The Germans already have the most advanced infrastructure and workforce in the world. In a country where the population is declining, fewer people are driving and taking the train, what do you want to spend it on? Fiscal stimulus in Germany won’t actually increase demand. For the world we’re in right now, their system works great. And spending money just to spend money is not something that’s an easy sell in Berlin.
KLC:Sticking with Germany, what are your thoughts on their upcoming elections this fall?
Peter Zeihan: Merkel wins it unless something dramatic happens, and even anything that would be dramatic, like in the law and order realm, would help her, not hurt her. I think the worst-case scenario right now is if they were to have a significant terror attack, and you got some support going to the Alternative for Germany party (AFD is a right-wing populist party advocating for the abolition of the EU). If the AFD get enough support to be a meaningful block in the Bundestag, that could give them a meaningful voice in the central government. That could scare a lot of people in Europe. Because some of these people think that the problem that the Nazis had is that they didn’t go far enough. Then the rest are unrepentant East German communists, I mean, these are not nice people. The threshold is 5 percent. Right now they’re polling about 9 percent, so we might have six parties in the next parliament.
KLC: What is the political calculus for Germany right now, as it relates to the rest of Europe?
Peter Zeihan:So long as Merkel is able to form the next government, and that’s kind of in the bag from my point of view, Germany will continue to be the adult in the room, and that’s something Europe desperately needs right now. That’s good for Europe, and so far the Populists are not strong enough. It would be very stable from a diplomatic point view within Europe, and between Europe and the United States, because then Merkel only has to have conversations with three people when making decisions as opposed to bringing in the party congresses. As relates to the rest of Europe, Merkel will want to tighten the budget deficit. Yes, this will tighten the screws across Europe, but from the German point of view, wholeheartedly, this is not tongue in cheek: this is how they think of it. If they had just done it this way from the beginning, we would have never been in this problem. Not the ECB, France, Italy, Greece, any of them.
KLC: What does that mean for risk sharing or tax transfers in Europe?
Peter Zeihan:Completely off the table, always have been. Macron is an avowed Europeanist for ethical reasons more than political reasons, and so, I don’t mean to suggest that he’s not going to float some of these. Just keep in mind that if we do get to some sort of pooled debt –or that 60 percent of GDP in government bonds that is shared debt and everything else you’re responsible for, that’s one of the ideas that’s been kicked around –he’s on the hook. It’s hard for me to say that, to the tune of 2-3% of GDP, the Germans are going to start pouring money into Southern Europe knowing that they’ll never get it back. So it’s one thing to say that I support Europe, and we need to be mean to the Brits. That’s very popular in Europe. But it’s their money, and the Germans have more than enough capacity to prevent it from ever happening. The French are likely to lose interest in issues like that when it becomes apparent that in an EU without the Brits, the Frenchactually have to pay in rather than take out.
KLC: With one of the largest trade surpluses in the world, why isn’t Trump setting his attention on Germany as a bad actor in the global trading system?
Peter Zeihan: He’s using NATO as a proxy for Germany.Merkel showed up at the White House. She was the third leader to visit, and she made the mistake of not bringing anything: a deal, a gift, a bribe. Call it what you will. Japan did. Britain did. China looks like they did. Germany didn’t. Merkel doesn’t have the options that those other countries have because she showed up, and she basically said, “You do realize that if you carry out these trade policies that you’re talking about publicly, it’s not just the end of Europe, it’s the end of Germany. Because Germany can’t exist without the American framework.”
Apparently, Trump’s response was something along the lines of, “Uh huh.” And then he handed her a bill on the way out the door for services rendered.But the German-American relationship was already on hiatus. The sort of things that Trump wants out of Europe and specifically wants out of Germany, Merkel is absolutely powerless to provide. From the Trump administration’s point of view, Germany doesn’t exist anymore because it’s not useful to the Trump administration. Which means that NATO doesn’t exist anymore. Now as with everything else with Trump, every 40 hours there’s a new statement, and who knows which ones are the real ones, but judging from the complete lack of back and forth between Berlin and Washington in the last two months, I’m pretty sure it’s over. The problem is, if there’s an every-man-for-himself approach, Germany loses. So, Germany’s just got to keep going through the motions to try to make the European system muddle through and hope that the Americans don’t actually pull the rug out, and hope that the Russians don’t actually roll. It’s a policy of hope now, because they have no tools to shape anyone’s behavior if the Americans aren’t involved.
KLC: Was that an ultimatum that Trump gave them?
Peter Zeihan: Yeah, pretty much, and it’s been roundly rejected now.
KLC: Didn’t the US since reaffirm support for NATO?
Peter Zeihan: Right, Trump had a meeting with the Secretary General of NATO, who reminded him a thousand NATO troops have died fighting terrorism. So he’s not lambasting NATO anymore, but he is not doing anything to reinforce it. The withdrawals continue. Beyond that I don’t know if there is a strategy.Which, you know, is basically an echo of what Obama did. If the US wanted to escalate, we could close Ramstein, a major air base in Southern Germany. That would be the clearest statement, and we’ve been steadily hollowing that out for 10 years now.It’s just a question of pace. I’m more concerned with what’s going on at the lily pad bases, which are being closed down left, right, and center. Again, not just Trump, Obama too. Lily pads are something that Rumsfeld put into place to establish forward supply locations. Rather than have 80 major bases around the world, we’ll only have 20 major bases, and we’ll have another 60 lily pads, basically reinforced warehouses with a runway, or a port, or both, where we can store all of our war material. And then when the time comes and there’s a hot spot, we’ll fly in the troops, and they’ll mate up with the equipment and go deal with whatever it is. The pace of technological change because of the Internet revolution and drone warfare –and all the lessons learned from Iraq and Afghanistan –meant that most of the equipment in those lily pads was no longer up to date, so they’re being closed down.
KLC: What do you think about Putin, is he looking for his window of opportunity in Europe?
Peter Zeihan: He was really confident until the Syria bombing, which really threw him back. Because under Obama, the United States didn’t do much. It was just incremental, incremental, incremental. Then under Trump, he was anticipating a bro relationship, and a broad scale American withdrawal from everything, and then Trump bombed Syria. Just before the bombings, Pence and Tillersonboth made statements about Syria saying that obviously Assad is someone who can’t be toppled, and he’s going to be part of any future political solution, so we’re not working to oust him anymore.
Then the chemical attack in Syria happened, and Trump changed his mind, and now Assad’s got to go, and so that shifted everybody’s perspectives because if the Americans are willing to reach out and thump things, then where and when and why, and what will trigger it? And so for Putin, all of a sudden, he went from having pretty much a foregone conclusion as to where things were going to go, to now, he’s got to guess again. This time, all of his best military equipment is in Syria, and Putin is exposed if the Americans decide to make a point of that. So, he just doesn’t know. The Russians are just as in the dark as the rest of us, as to what Trump is thinking, day to day.
KLC: We read that of the 59 missiles that ended up going, only 39 hit the air base?
Peter Zeihan: That was Russian propaganda, I don’t believe that for a second. We had better hit rates on that back during Desert Storm in 1990-91.Now whether or not that made it a good tactical strike is another topic, but I’m sure they hit the airbase.
The Americans did give the Russians a heads up, so that they could get all their troops out. The question people are discussing is how much damage was actually done, but that’s not the point. The point was that it made everybody all of a sudden reassess whether or not the United States was in the game. And everyone’s got to draw their own conclusions, based on what’s going on. So the Syrians are asking, does this mean we can’t use certain weapons and certain tactics anymore, or we’re going to get thumped? Russians are asking, does this mean that the entire periphery is in play again? Will the Americans do something when we move toward Kiev? North Korea has to be asking, are we next? And the Chinese have to be thinking, if the Americans are willing to actually throw ordnance over topics like this, we need to have a meeting of the minds with them to make sure the US doesn’t destroy our initiatives and threaten our system. So Xi showed up and was much calmer –well, let me rephrase that, Xi was there when it went down.
KLC: So what does Russia do at this point?
Peter Zeihan: It sounds like wait and see. Putin is running out of time. I expect things with Ukraine to get a lot more aggressive, but he really needs to know if NATO is going to exist. They can’t wait long though. Their army is shrinking pretty aggressively now, we’re past the tipping point. By 2022, they’ll have half the military strength that they had last year.
So, now granted, with half the military strength you could still conquer Ukraine, it’s not hard. In Russia’s ideal, there will be a firm break between the Americans and the rest of the NATO alliance, and then you go into Ukraine. But Trump just pushed the timetable back a minimum of six months.
KLC: What would it take for the US to completely pull out of NATO?
Peter Zeihan: It’s the American troops in Germany that make the difference. Because as long as those are there, there is a commitment to the lives of the American soldiers, regardless of what you think of the alliance.And we still have troops in Italy and Turkey, but we’re using them less.
KLC: Wasn’t Turkey courting entry in to the European Union a handful of years ago?
Peter Zeihan: Yeah, that’s completely over.Putin’s position is very clever, but it’s not very smart, if that makes sense. He’s doing everything he can to sow problems within all of these institutions that have traditionally hobbled Russian power, most notably NATO and the EU. But if you’re successful in that, then all of a sudden you’re dealing with these countries one-on-one. And while that sounds great, and for the United States, it really does work fairly well, some of these countries when they’re one-on-one get really dangerous.
So if you get the Germans or the Turks or the Swedes nationalistic, that has never worked out for the Russians in the past, World War II being the most brutal example. The Russians fought eight wars with the Turks. When the Turks were in NATO, they didn’t fight one, because the Turks were partially constrained. If the Turks start acting in their own best interests, leaving out consideration for everyone else in the NATO alliance, the question is, which way are they going to go? And they’ve got a lot of options. Economically, I’ve always felt that the Balkans is the best bet for them.
But it’s not clear that the Turks are looking that way right now, because Erdo?anis playing the Islamist card so fast and furious. Syria looks attractive, from a purely political point of view. From a military point of view, it’s a disaster. But if the Turks really wanted to make a difference, they could do so, and impose a new reality on Syria, probably in less than six weeks. Whether that’s a savvy geopolitical move is a whole other topic. But they have the capacity.
I have no doubt that if the Turks wanted to, and they were willing to use their 600,000-man army, the war would be over in two months. The instability would be over, and the Turkish army would be in charge of logistics and food distribution. That would probably choke off the migrant flow overnight, without the Turks actually having to shoot people at the border. But then they take ownership of the migrants, and that’s the problem. And then you talk about Iraq. When you go into Northern Iraq, you get the Kurdish zone, but that’s where the oil is, which would solve a lot of problems, and generate new ones. So all of a sudden, the Kurds, instead of being 20 percent of the Turkish population, are 30 percent. That’s a bit of a problem. You go into the Caucasus: you’d be welcomed into Azerbaijan and Georgia, but the Armenians would fight you tooth and nail. Sure, you get that energy supply, but now you’ve picked a direct fight with the Armenians, the Russians, and the Iranians. Maybe that wasn’t the best move either. So the Balkans seems like the easiest option for Turkey.
KLC: Can you talk about events in the UK?
Peter Zeihan: Theresa May is smart. She’s really smart. She understands how everything is changing, and she has made of series of brilliant moves in the last three months in my opinion. Let’s deal with the broader situation, then let’s deal with Brexit, and then go to London specifically. The broader situation is this: the relationship between the United States and its allies is now much more transactional. You have to bring something to the table if you want the Americans involved. So she shows up to President Trump, and she says, “OK, we’ve got two supercarriers that will both be operational by 2022, and we want to see what we can do to fully integrate them into your fleet structure. We have to double our diplomatic budget because we’re going to have to negotiate all of these free trade deals with everybody. We’re going to have to double our intelligence budget because all of a sudden Europe is a target instead of an assistant. We want to share everything that we get from all of that with you. Can we have a free trade deal?” Brilliant. So Trump agreed on day one, and they started talks. It’s technically illegal in the EU, but whatever. What are they going to do, kick the Brits out of the EU? It’s a bilateral deal. She’s done the same thing with the Canadians, India, Turkey, Australia, and New Zealand. The talks still have to conclude, but getting to the agreement — that’s the hard part — everything else is technicalities. That’s the broader situation.
Now let’s talk about Brexit. Think about what’s going on in Europe. Now that they’ve gotten over this little hiccup of the French elections, the Europeans are not dealing with all the problems they’re facing … it’s all about Brexit. How to punish the Brits, not just for having audacity to leave, but for having the audacity to start planning what happens the day after they leave, because that’s illegal. So how do we punish the Brits for slights real and imagined, even though there’s a Russia crisis, a banking crisis, a debt crisis, a consumption crisis, an export crisis, a Turkey crisis, and a Syria crisis? They’re blocking out the real problems that they’re facing in order to deal with something they don’t even have control over. May is willing to do the hard Brexit, and if that’s your
position then none of the rest of it matters. I don’t mean to suggest that UK’s future is rosy: the next two years are going be brutal at a minimum. I mean you don’t have 20 percent of your GDP suddenly get amputated and just walk away.
KLC: With a hard Brexit, do you see a sizeable hit to the UK’s GDP over the next couple of years?
Peter Zeihan: Absolutely. It’s going to be a depression. Even in the best case scenario, it’s unavoidable. It will go beyond a recession into a broad-scale structural readjustment of asset prices in the UK, domiciled assets, property, you name it. There will be at least a 10 percent reduction in the British standard of living over the next 2-3 years.
The banking sector won’t decamp enmasse, but enough of it will leave. Some will go to Frankfurt, more will go to New York. Because despite all of the things that are going on with the Trump administration, New York is just more capable of taking this stuff, and if you are a European bank and you want access to the Eurozone, and location doesn’t matter, all of a sudden London is not as attractive as it used to be. Anything that’s there could get caught in the crossfire in the EU talks. You don’t have to worry about that in New York. Not to mention it’s cheaper. The UK will come out of the depression, in my opinion, stronger that they would have if they would have rode the European Union down.
KLC: If Europe becomes unstable, wouldn’t the UK be a natural place for some of that spare capital to park?
Peter Zeihan: When the EU breaks, yes, the UK will be a natural place to park capital once again. But until the EU breaks, no. And also remember that when the EU breaks, if you think their trade relationship is taking a hit now, when the Euro dissolves, it will hit everybody in Europe. There was a certain quiet hope in the UK that we would have gotten the two wackadoosin the final round for the French elections. If that had happened, the Brexit talk is already over, because the EU’s already over. From a certain point of view, that would have been delicious, but no such luck.
KLC: So will the UK be out of its depression by the time the EU breaks?
PZ: It’s up to the Europeans.There are so many moving parts to figure out. At what point does the EU actually keel over? It could be the Trump administration to do it. It could be the Russians. You could have enough a wall of refugees flowing into Europe that they actually start shooting people, and that causes a political crisis that would probably make the EU collapse within six months. But Europe has done a decent job of muddling through. They haven’t fixed anything, which means that when they do have their crash, it’s just going to be that much worse.
KLC: Economically, everybody’s looking for that big data point that signals the collapse in Europe. What might be the tripwire?
Peter Zeihan:I don’t think it’ll happen until after the British elections (June 8) because we have to have some more meaningful clarity on the negotiating positions in Europe, and just how difficult that’s going to be. In the UK, May will win in a landslide, the question is how big of a landslide. Assuming she wins, then everybody wakes up the next day and says, OK, hard Brexit.
Then she or her negotiator will have their first meeting with the Europeans, and at some point early on, there’s going to be a credible leak from the British side about just how brutal these talks are going to be. It doesn’t matter if it comes from the European side, it’s just their rhetoric. Once the British side begins to talk that way, it will mean a hollowing out of London, an end to automotive supply chains, and losing Britain’s single largest trade partner. Once that sinks in, corporate Britain will have no choice but to adjust. That’s how it starts.
KLC: Why isn’t corporate Britain preparing now, if they see the writing on the wall?
Peter Zeihan: Because there’s still hope. I think a big piece of why May called the election was to make it clear for everybody that hard Brexit is going to happen, unless the Europeans change their position.
KLC: What would entice the Europeans to alter their position?
Peter Zeihan: Considering all the crises they have, I would think the EU would want a slightly more constructive relationship with the strongest economy in their nearby vicinity, but they can’t let the Brits go cleanly, because if they do, why wouldn’t anyone else leave? If Britain goes and they’re not punished, Greece goes, and it walks away from the Euro debt because it’s all held by the ECB now. Being in debt to a sovereign monetary authority that can’t even negotiate with its own members competently, you might be able to walk away from that debt. Then, of course, you’ll get the Italians saying, hey, all of this bank debt is denominated in Euros, we’re going find some way to foist that off on the ECB, and then we’ll take a walk too. So the EU has got to make Brexit as painful as possible. But in doing so, they’re just causing themselves more problems. At this point there are no good solutions.
KLC: Does Brexit put Europe into a recession then, next year as well?
Peter Zeihan:I don’t know if it will be next year. They’ve had six in nine years of recession now, so it’s not exactly a bold forecast, but Brexit will definitely cause problems. This is as good as it gets right now in Europe, economically. There will be another recession caused by Brexit, all else being equal. The problem is all else is not equal. All else in the mid-to-long-run looks pretty bad. I’m still worried about the Italian banking situation. We’ve had two more small Italian banks crash since the beginning of the year. The Italian banks will either have to be bailed out, or they’re going to have to crash, and if they crash, that’s the end of deficit spending in Italy. And since Italy hasn’t had a government in a long time, that’s it, they fall into depression.That assumes that the government doesn’t actually flip this year, which it probably will. We’re going to have a comedian as Italian Prime Minister.
KLC:So what’s the next thing from a political standpoint we should be watching in Europe?
Peter Zeihan: TheBritish elections. It’s just a question of how big of a sweep it will be: right now it appears that it’s going to be a blowout, with Labor having catastrophic losses. Beyond that, Britain and the EU go head-to-head in the negotiations. Do you know who’s in charge of the negotiations from the European side? Michael Barnier, an avowed Europeanist who thinks that we should abolish national identities so that the European Union can be a superstatethat wipes away all the other historical artifacts, like the Russians, the Chinese, and the Americans.
The talks will begin as soon as the Brits show up, probably late June or July, something like that, over the summer. Theresa May will finish her complete housecleaning in Parliament. She’ll come up with a series of policy papers, of which Brexit will probably be the single most important one, the relationship with the United States will be the second most important one, and then we’re off to the races. I think over the summer the world will realize that’s the path we’re on.
KLC: Do you think the UK will do a big fiscal stimulus?
Peter Zeihan: Oh, definitely. Definitely.
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