Steen's Chronicle: Pax Americana - beginning of the end or The End?
Chief Investment Officer
Summary: "Victory has a thousand fathers, but defeat is an orphan." - John F. Kennedy. According to the great quote from Kennedy, the chaotic exit from Afghanistan is an orphan that has everyone pointing fingers on who is responsible for the end of a failed attempt at nation-building by the US and its allies in the country. But that misses the real point, which is that it has long been a predictable coda to that conflict and represents at very minimum the beginning of the end of Pax Americana, the implications of which are the subject of this Chronicle.
Before you jump up from your chair and start yelling, no I am not saying the US is “over” or that it will not be back again, but it’s the completion of a foreign policy which was set in motion by President Nixon’s Nixon Doctrine in 1969.
It states: “…the United States would assist in the defense and developments of allies and friends", but would not "undertake" all the defense of the free nations of the world”. The US now wants a smaller role, not as the world's only policeman, rather with a shared role going forward, with even the “friends” being cut from the former deal as seen by first Trump's anti-NATO stance. Now, President Biden has completely blind-sided his “allies” with the chaotic exit from Afghanistan after they were asked in 2001 to step up and help the US in the fight on terror. Make no mistake, we now have a true diplomatic crisis between the EU, UK and the US.
By the way, Saxo had the great honor of hosting the former US ambassador to Afghanistan Hugo Llorens in a long-form interview and Q&A just this week. Ambassador Llorens insights are a useful accompaniment to my perspective.
This does not mean that everything the US did in Afghanistan was pointless, as former Ambassador Llorens made clear in the excellent SaxoTalk linked to above: There have been significant increases in health, schooling, medicine, infrastructure and not least communications (28 million mobile phones for a population of 35 million) in Afghanistan, but this improvement is now at risk as the Taliban is giving a cold shoulder to the technological and societal advances of one of the youngest populations in the worlds as more than 70% of Afghans are under the age of 25! Afghanistan may have become even more difficult to rule than ever - it is certainly not the Afghanistan of 2001.
There is no doubt that President Biden is only executing on the wish of the American populations to exit all major deployments of troops in combat zones overseas. With these moves, the US is shedding its global commitments. And polls suggest a 60-70% backing for the Afghanistan exit. That’s the pollical reality.
Another reality is that the US leaving Afghanistan after also pulling out of Iraq deepens the military and political vacuum in the Middle East. Even more practically the US itself is protected from the immediate impact from the exit, while Europe and Middle East now need to deal directly with three major threats:
- Refugees. During the Russian occupation 1.5 million people fled Afghanistan to Iran. NGO’s put the likely refugees number now at 2.5 million soon looking for asylum elsewhere. These are people in need of a new future.
- Terrorism. The whole strategic initiative of going into Afghanistan was driven by a desire to shut down global terrorism as terrorists were harbored, trained and financed out of Afghanistan. Despite the attempts by the Taliban to downplay the situation, a new resurgence of terrorism could take root inside the country, in particular because the Taliban will be short of money, access to resources, and ability to control the young population, with many ethnic faultlines within the country and with its neighbors.
- Drugs. Opium has long been the chief source of export revenue outside of foreign aid.
Refugees during the Syria crisis changed the political landscape in Europe and globally, there is now an aggressive anti-refugee policy embedded into most even liberal governments including an extremely harsh policy conducted in my own country by the ruling Social Democrats. Most political analysts see this as a game changer in every poll. Its sadly more about the optics of immigration than about helping people in true distress.
The bigger question, the one that takes into account the longer term consequences is really down to the question of: Is this the end of Pax Americana? Being an economist by training the answer is: Yes and No.
The "Yes" part goes to the fact that the US right now is pivoting away from foreign policy involvement, the hard power concept born in the ashes of 9/11. Many observers, among them UK Foreign Affair Committee Chairman Tom Tugandhart, suggest that it has been over for a while, but that Afghanistan is the “catalyst” or clear sign.
In his words: “In 1956, we all knew that the British Empire was over but the Suez crisis made it absolutely clear. Since President Obama, the action has been of U.S. withdrawal, but my God, has this made it clear,” Mr. Tugendhat said in an interview. That’s not necessarily great news for Russia and China, he added. “The reality is that Chinese and Russian bad behavior is only possible in a world that is U.S.-organized,” Mr. Tugendhat said. “You can only be an angry teenager if you know that your dad is still going to put petrol in the car the next day.”
This analogy of controlling the teenagers also is central to the policy shift inside President Biden's cabinet. President Biden has defined his Presidency by three C’s: Covid, Climate and China. Let's take the last of these first: “Controlling” - or more politely competing with the new global rival China - is now the main foreign policy focus.
The economic reality is also that the US no longer can afford the ambitious overseas deployment of troops. Although the military spending as percent of GDP is at a steady 3.5%, it is a constraint on the ability to change the fiscal mix in the US. Ambassador Llorens did not expect any major change in US military spending and pointed to the US presence in Qatar, which could be increased to help the “stealth” containment of both Afghanistan but also the wider region. But my macro background dictates to me that the China focus needs “resources” from other areas including from the political unpopular overseas deployment of troops.
Making China the focus is also something that should concern us a market investors. The anti-China lobby in US politics is getting bigger and bigger, and it remains one of the few issues agreed upon across the aisle in Congress. The negative tone is returned with equal aggression by Beijing and the increasingly nationalistic call to action seen over the last two weeks is for me personally one of the biggest shift of the tectonic plates we have seen since 1979 in China. See The profound revolution for the kind of commentary that has been encouraged by official sources. A new "China versus the US" paradigm (and vice-versa - both are protagonists, let's be clear) will create an endless stream of micro changes which will compound into major macro changes.
The "No" argument for the end of Pax Americana is the fact that the US is still leading in many technology areas, overall innovation, open society and military strength.
That there is a fundamental identity crisis in the US going on is for everyone to see, and it will interesting to follow the 2022 mid-term election and its outcome as the hard-left in the Democratic party fight the old guard in the party, right now mainly represented by Senator Joe Manchin. Is it MMT forever or a more balanced version and vision for the US. (Link: Joe Manchin – WSJ: Why I wont support spending another 3.5 tn. USD). With the Democratic Party split, the division or lack of the GOP will be easier to live with, but its also a party struggling to bring a coherent vision for an American renewal (as opposed to simply "Drain the swamp!", etc.).
For us in SaxoStrats, the Afghanistan exit by the US creates the following short- and long term impact on markets:
- Oil: the Middle East risk premium will need to increase. Classically, geopolitical risk premium ranges from 0 to 10 dollars per barrel. We think the US exit justifies at least a $5 increase, in particular as the nuclear deal talks in Geneva with Iran seem to have broken down.
- There will be increased spending fiscally on policies aimed at countering China. This is less about military deployment and more about investment to reduce dependence on China - or even overseas generally for strategic areas like medical equipment, semiconductors and other key industries. Read: real growth is minimal to non-existent in aggregate on this kind of spending, but it is clearly inflationary.
- Defense spending in rest of the world to rise. We have already seen Japan forward a record rise in defense spending with a new $50 billion annual budget plan for next year. And throughout Europe and UK, select committees are going over all the same arguments I have put forward above. This means that the political incorrect response for investors could be to increase exposure to defense-related industries. Peter Garnry has put together a basket of companies that should see increased sales. Again let me stress we neither support nor sanction increase spending on military, but it is a fact that less US military spending will have to mean more European spending.
- US Dollar. There are multiple challenges to the US Dollar's reserve status: The dismal economic outlook in the US, new digital currency and crypto technology, the rise of China, the reversal of globalization and as part of that, the reduced or weakened Pax Americana. We believe the cyclical weakness of the US will be sustained over the next decade, as the rest of the world needs to take over on growth while the US is regenerating / redefining its domestic and foreign policy.
- Finally, the single biggest threat short and medium term is the likely increase in refugees. It is yet another humanitarian crisis waiting to happen, and if the Syria crisis is any indication, it will again transform European politics towards xenophobia.
The conclusion for me, is this:
The world changed on 1 September. Whether this is the beginning of the end or the actual end of Pax Americana of course I am not smart enough to know. What I do know is that the micro changes going on right now in the world will change the macro tectonic plates and that a key global power reducing its presence on the global stage will open up a new era in geopolitical developments. We need to be ready and nimble.
Latest Market Insights
Q4 Outlook 2022: Winter is coming
- Winter is coming to the financial markets as central banks are tightening their grip. How spring will look is still a question.
European energy crisis: it will get worse before it gets betterThe winter in Europe will be tough, but whether the result is political chaos or sustainable, innovative solutions is still undecided.
A difficult and volatile quarter awaitsAs the year draws to an end, commodities continue to be at centre stage of the world with growth pockets political uncertainty.
The bright side: crises drive innovationThe positive spin on crises is that they come with solutions. It is worrisome that deglobalisation may be a response to this crisis.
Green transformation in China: renewable energy and beyondGoing green, China needs to span numerous energy sources to ensure stability, as every source comes with a challenge.
Asia: Intermittent solutions, but a faster renewable adoption curveAsian energy supply is being squeezed. This and the adoption of renewables may change the investment sentiment in the region.
FX: A Fed thaw needed to deliver a sustained USD turn lowerThe US Dollar can keep momentum when the Federal Reserve continues to tighten, leaving the rest to play to their drum.
Autumn can become ugly for equities and bond holders. Comfort for Dollar longsTechnical analysis suggests that equities could face a tough Q4 as could fixed income. US Dollar positions could provide some upside.
The next stock market sector to watch, with stocks going nuclearAs the world scrambles to find affordable, sustainable energy, nuclear is getting attention from politicians and investors alike.
The crypto space is getting cold when the hype disappearsCryptocurrencies face a winter of their own as retail investors and governments are asking tough questions.