30 December 2015

BARRON’s Sits Down With Noted Historian/Author Niall Ferguson Who Looks Ahead To 2016 And Beyond — And Sees Troubled Waters Ahead; Is Saudi Arabia, The Iran Of 1979?

December 28, 2015 ·
Noted Historian And Author Niall Ferguson Looks Ahead To 2016 And Beyond — And Sees Troubled Waters Ahead; Is Saudi Arabia, The Iran Of 1979?

Vito Racanelli, a writer for Barron’s had an interview with Niall Ferguson, historian, Harvard professor, and author of more than a dozen books on the nexus of economies, finance, and geopolitics, in this weekend’s (Dec. 28, 2015) Barron’s. Professor Ferguson “argues that America’s abdication of its role as the world’s policeman is one cause of the global economic malaise. U.S. policies, or lack thereof,” he contends, “have allowed terrorism to breed; and dictatorial states such as Russia and China to assume a larger role in world affairs.”

“The author of “Civilization: The West And The Rest,” Professor Ferguson told Mr. Racanelli that “China’s attempt to move to a true market economy probably will fail, potentially causing serious disruptions to other markets. He likens Saudi Arabia to Iran in 1979 — a state ripe for destabilization. In the U.S., he sees tax reform coming, but worries that America’s love affair with regulation will continue to dampen its growth prospects. India gets a thumbs up; but, Europe’s prospects are bleak,”

Professor Ferguson recently announced that he’ll leave Harvard next year to become a Senior Fellow at Stanford University’s Hoover Institution,” Mr,. Racanelli wrote. Professor Ferguson spoke with Barron’s staff at their offices just after the November terrorist attacks in Paris,” and, “was every bit as thoughtful and provocative as he was three years ago,” Mr. Racanelli added, when he previously spoke to the publication.

BARRON’S: The U.S. economy has been growing by only 2 percent, or 3 percent a year. Why isn’t it firing on all cylinders?
Professor Ferguson: “There are at least three theories. The seven-year hangover theory suggests that the U.S. will shake off the effects of the 2008 financial crisis next year. The secular-stagnation theory posits that, for a variety of reasons, the economy is in a depressed state. That is most obviously [expressed] in interest rates.”

“I’m attracted to a third argument, the geopolitical one, that says growth in modern American history has tended to be high at times of national strength, and low at times of national weakness, because our weakness has ramifications for the world as a whole. One has to combine the three theories to understand why growth is lower than expectations. It isn’t low-based on a pretty long-term average, but it is sluggish compared with the glory days of the Cold War.”

BARRON’s: What was so glorious about the Cold War?

Professor Ferguson: “There were two phases of growth, one associated with the Eisenhower and Reagan administrations, and one with the depressed period in between. Since 9/11, things have gone from bad to worse. We find ourselves in a deflationary version of the 1970’s, marked by stagnation, not stagflation. [Russian President Vladimir] Putin is doing his best to give us reasons to man up. But, we’re not really doing so.”

“The global economy needs a strong hegemonic power to reduce conflict, ensure freedom of the seas, and so forth. In the 19th century it was Great Britain, and for much of the 20th, America. But in 2013, POTUS Obama said there was no global policeman. There are deleterious consequences if the leading power in the world abdicates its leadership role.”

BARRON’S: What are some of these ramifications?

“Part of the reason the world isn’t as buoyant as it might be, is that Europe is doing much worse than the United States. It doesn’t help Europe to have a massive influx of real and “not so real” refugees. Some 220,000 people arrived in the European Union (EU) in October; a direct consequence of the disintegration of order in a whole bunch of countries, Syria principally, but not only.”

“The U.S.walking away from the Middle East has had a direct impact. We’re only beginning to see the ramifications, in Paris most recently. It isn’t going to stop there There is growing anxiety in East Asia about the rise of China. Japan remains a large economy, but a depressed one — in yet another recession. Economists tend to underestimate geopolitical factors because they aren’t in their models. Global order and stability need to be underwritten. it doesn’t just happen spontaneously.”

BARRON’S: Are you suggesting that the U.S. ought to be the world’s policeman?

Professor Ferguson: “Somebody’s got to do it. it better not be the Chinese, or the Russians. The market system requires as effective state that enforces the rule of law. That is true internationally as well. As the world becomes less secure, it becomes a less safe place to do business.”

“A world in which the U.S. yields regional power to China, or Russia, is one in which the rule of law is driven back. We underestimate the extent to which the age of globalization depended on an American underwriting, and that is gradually unraveling.”

BARRON’S; Can the U.S. afford to keep the peace?

Professor Ferguson: “The U.S. has a fundamental problem. Gradually, its national security is being squeezed by Social Security, particularly its health-care system. It will be squeezed by the burden of interest payments on the Federal debt, as interest rates go up. In theory, as the biggest economy in the world, the U.S. should be able to afford to build up its military power. In practice, the congressional budget sequester was a blunt instrument applied to the defense budget, cutting it indiscriminately. The U.S. should be investing to maintain its [military] lead, particularly in areas where it is vulnerable, such as in cyber security. No matter how many aircraft carriers we have, it might not be that big of a technological leap for us to be matched in the new theaters [domains] of war that are emerging.”

BARRON’s: But, as you note, our finances are hobbled.

Professor Ferguson: “Entitlements are the obvious problem. Republicans discovered that if you want to cut entitlements, it is hard to win the presidency. I’m optimistic that the U.S. can make its health-care system far more efficient, and less expensive as the new technology comes into place. The employer-pays insurance system is ripe for revolution, in the way that Uber is revolutionizing transportation. We will see similar types of companies revolutionizing health care.”

Barron’s asked Professor Ferguson about the “toxic combination of litigation and regulation in the U.S.; and, the odds for any kind of meaningful reform. Professor Ferguson said he was “not optimistic. Tax reform, including reducing corporate income tax so that U.S. companies can better compete internationally, is also something dearly needed and long overdue Professor Ferguson contends.

BARRON’s: Let’s turn to Asia. You have said that regarding China as an emerging market is absurd. Why?

Professor Ferguson: “It is now the second-largest economy in the world, or the largest based on purchasing-power parity, with an influence on the global economy — second only to the U.S. China is sui generis. Is China going to go further in the direction of a market economy? Will it reduce the importance of state-owned enterprises; and, remove the state from the financial system? Is it going to open its capital account and allow the Chinese to invest abroad freely? Each answer has ramifications for the rest of us — like it, or not.”

BARRON’s: Give us your answers.

Professor Ferguson: “We don’t know whether China will be more of a market economy in ten years from now. It is risky for a one-party state to continue increasing the economic freedom of its citizens. President Xi Jinping, who is more interested in power than anything else, understands this well. Consequently, plans for privatization of state-owned enterprises, liberalization of the financial system, and the opening of the capital account will remain plans, but won’t be implemented.”

“China has created the biggest middle-class in history, but middle-class people want property rights. That implies law courts and officials who aren’t corrupt. The moment you demand these things, you are asking the one-party state to loosen its grip on power. The Chinese [Communist Party] are terrified of anything like that.”

BARRON’s: What impact might Jinping’s foreign policy have on markets around the world?

Professor Ferguson: “To ensure the one-party state’s legitimacy, Jinping won’t shy away from a relatively saber-rattling foreign policy, because this plays well [domestically]. There is also an element that isn’t propaganda. China is building up its naval capability, modernizing its pretty antiquated army. It has a financial diplomacy that has proved effective. The Chinese have been using their considerable resources to win friends and influence people around the world, including in Central Asia and Africa. China says, “Let’ us build your infrastructure.” That increases its leverage over a whole bunch of countries that the U.S. has neglected.”

BARRON’s: What is the outlook for India?

Professor Ferguson: “The Indian economy looks to be growing faster than the Chinese economy. India is good for a couple of reasons, including demographics, which turn out to be a lot more important than most people thought. India did not have a one-child policy, unlike China, whose work-force is shrinking. India has a rule-of-law, — slow maybe, but it is there, and a representative government and a free press. Unless you think the success of the West is pure luck,which I don’t, those are advantages. There are many thickets of vested interest, but I’m broadly bullish about India’s prospects. The problems India faces are flexible, like infrastructure and housing. China’s problems…..are much more difficult.”

BARRON’s: Will the Middle East royal the markets in the year’s ahead?

Professor Ferguson: “I expect next year [2016] to be more violent than 2015. Many investors don’t realize that since the outbreak of the Arab Spring in 2011, fatalities due to armed conflicts are up by a factor of four; [while] terrorism is up by a factor of six.”

“The events in Paris are a reminder that the jihadist network doesn’t confine itself to the majority-Muslim world. It is now embedded in minority-Muslim communities all over Europe. There will be more such attacks; and, at some point — the terrorists will be successful once again in the United States. [Barron’s notes that this interview was done before the San Bernardino terrorist attack on an office Christmas Party. The resources that go into producing radicalization, aren’t about to disappear. Networks are difficult to decapitate.”

“The President has failed to understand this because his model is decapitation. You think, let’s take out the boss. Then, you are amazed to find the network [still] grows. We won’t see this go away in the next ten years. The threat of violent instability in the region will go up, and probably will affect Saudi Arabia. Support for the Islamic State is high among the Sunni population.”

BARRON’s: Why is that?

Professor Ferguson: “An Islamic State can credibly argue that the Saudi Royal family is corrupt, Westernized, and hypocritical. The family itself is divided. Saudi Arabia is a weak link, the way Iran was in 1979. If you had to ask what headline would move the markets tomorrow morning, a revolution in Riyadh, especially a messy one, would be a pretty good answer. You could see a big terrorist attack on Saudi [oil] facilities, and markets would move up the price of oil,” probably back near the $100 per barrel price in very short order.

BARRON’s: The dollar is strong and commodity prices are weak. What does that mean for Brazil and Russia?

Professor Ferguson: “There comes a point, when an investor says, “Hey, that’s attractively priced.” Argentina has been one of the great trades of the year. You might ask, “Where is the political problem horrible?; and, where it is about to get solved?” It is pretty horrible in Brazil, and I don’t see a fix in the short run. T, hings will be solved in Argentina, more or less. South Africa? No, that looks bad politically. Turkey? [Prime Minister Recep Tayyip] Erdoganis a dodgy customer. Egypt? I don’t like the way it’s going.”

“The key is attractive prices and political stability. Money is going to start flowing back into emerging markets that don’t have a political problem, such as Indonesia, and maybe Malaysia. In Russia, suppose the sanctions get relaxed, as seems likely next year. Russian bonds have been one of the great performers this year [2015]. Everybody was to negative about Russia. There are some interesting opportunities in the rest of the world. It is hard to see the dollar strength story continuing indefinitely.”

BARRON’s: What is the biggest risk to global markets in 2016?

Professor Ferguson: “China. It was so crucial as an engine of growth through the financial crisis. If there is a policy error in China, it could cause huge instability. The government could ease restrictions on cross-border capital flows, which would result in a great wall of money coming out of China. Money would be deployed in Western assets, and it might be difficult for China to cope. Imagine the devaluation impact on the renminbi, and the effect on all other emerging markets — if China suddenly devalues by 20, or 30 percent.”

“On the other hand, if Jinping turns the clock back, this could lead to a big down-side shock.”

BARRON’s: Will Europe get its act together?

Professor Ferguson: “Europe faces three extraordinary challenges. It wants to have a foreign policy to be able to influence the fate of Syria; but, it can’t act independently of the U.S. because it has slashed its defense capability. Secondly, Europe can’t stop this huge wave of refugees. The border is enormous, vastly larger than the Mexican border with the U.S., and much of it is a sea border.”

“The biggest problem is the fifth column within Europe — people who aren’t loyal to their European states, even though they are citizens, second- and third-tier generation. Potentially, there are thousands of jihadists, or sympathizers.”

“Europe’s problems are unsolvable. Anybody who thinks this great wave of immigration solves Europe’s demographic deficit….hasn’t been to the suburbs of Paris.”

My two cents

Professor Ferguson is a very thoughtful man and is always worth listening to. I do not share his concern about Social Security, as I believe we can, and will find a way ahead for that safety net. Addressing our $18T+ national debt, would be made easier if we could grow the economy at 3+ percent; but, as long as we continue to go down this road of bigger government, excessive regulations, and a tax policy that punishes and vilifies wealth, we won’t get there.

I also think that the Islamic State’s philosophy and idea can be substantially undermined if we initiate and conduct a 21st century version of the Nazi war crimes trials; and, charge and convict al Baghdadi and his key henchmen with crimes against humanity.

Saudi Arabia however is a looming potential black swan. V/R, RCP

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