Friday, 1st of March 2019
“He is not a Pashtun who does not give a blow for a pinch.”
– Pashtun Proverb
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Markets were broadly negative this week in the face of unnerving developments in Asian geopolitics and after the White House offered conflicting accounts of the state of progress in US-China trade talks. On Sunday, President Trump had indefinitely suspended the imposition of tariff hikes scheduled for 2 March. However, the US Trade Representative quickly poured cold water on the idea that a deal was imminent given disagreements over the depth of Chinese structural reforms needed. Soon after, the Director of the National Economic Council declared that the US and China were “headed for a remarkable…deal” with “unparalleled” enforcement mechanisms. Confusion reigned, before investors exchanged glances, shrugged and focused attention elsewhere – there was, after all, a lot happening.
One consequence of the US government shutdown was a delay in the release of hard data concerning the US economy’s performance amid the market carnage of Q4 2018. Forecasters were left guessing as to the damage caused by slower growth in China and Europe and the deteriorating prospects (at year-end) for a US-China trade deal and tidy Brexit outcome. Meanwhile, a trickle of disappointing figures fed the bears. However, we finally learned on Thursday that the US cooled less than expected during the fourth quarter, with GDP up +2.6% annualised. Consumption managed a +2.8% expansion, despite weaker retail sales, thanks to disposable income growth of +4.1%. Business investment also jumped +6.2%, while the Chicago PMI hit 64.7 (vs. 56.7 expected), demonstrating the strength of Midwest manufacturing under Trump. To be sure, the Q4 GDP print is well below the remarkable +4.2% and +3.4% growth rates registered in the second and third quarters, respectively. However, any stimulus from the Republicans’ $1.5tn tax cut in late 2017 was always going to fade. Moreover, there is little hope for similar measures in the new Congressional session now that Democrats control the House of Representatives and are gearing up for 2020 Presidential elections. So slower growth it is, but a US recession (much discussed at the start of the year) is highly doubtful. This augurs well for US equities and the dollar, but we are mindful that Mr Market likes to jump around.
The collapse of the Trump-Kim Summit in Hanoi came as a surprise to few. In the run-up to the event, the President put considerable stock in his ability to charm Kim Jung-Un into ditching his nukes and embracing reforms that could boost living standards in the hermit kingdom. Vietnam was floated as a possible model: a communist country which opened up to the West and triggered an economic boom without ditching its oppressive political structures. But you can’t build enough trust over an afternoon’s tea and biscuits to roll-back decades of mutual suspicion, even if you both share a passion for American cinema and dodgy haircuts. Kim told Trump that in exchange for demolishing uranium-enrichment facilities at Yongbyon and committing to US inspections of the complex, he wanted all sanctions lifted. He also promised not to test nuclear and long-range missiles going forward. In other words, the Chairman agreed to demolish some of the DPRK’s nuclear infrastructure – having already developed an arsenal of nuclear weapons – and made assorted promises about future behaviour. In return, the US would have to give up all its leverage over the regime. This was a bad deal and Trump was right to walk, but negotiators must have told the President that the two sides were poles apart: any deal will necessarily take years to thrash out and the North Koreans know that it must outlast the Trump Presidency to be worth anything. Looking ahead, the US has time on its side given the growth of unsanctioned markets in the DPRK since the famine of the mid-1990s. Indeed, some reports suggest that close to half of economic activity is now driven by the informal private sector. Together with the greater penetration of outside information, which is rapidly changing previously negative perceptions of the performance of the South Korean economy, this presents a major challenge to the North Korean regime. Domestic political upheaval would be a bloody end to a grim experiment in social engineering, but at this point in time it is at least as likely as a deal to end the country’s nuclear programme.
Another geopolitical rupture this past week has been a rapid thawing of the frozen conflict between India and Pakistan over Kashmir. The two nuclear-armed states have been to war over the region three times since 1947 and skirmishes at the de facto border are a regular occurrence. Tensions have flared up since Islamist militants based in Pakistani Kashmir killed 40 Indian soldiers in a suicide attack on 14 February. India claims to have evidence that the Pakistani security services (the ISI) were involved, and suspicion is probably warranted: Pakistan has long conducted asymmetric warfare through Islamist proxies based in its more powerful neighbour in order to contest Kashmir while maintaining plausible deniability. (Today this strategy appears myopic, having led to the growth of sectarian extremism at home with some organisations so powerful that the state struggles to control them.) India is now shelling suspected militants and launching air raids into Pakistani territory. One pilot whom the Pakistani military shot-down and captured has since been released, but events are moving quickly. India is on the brink of elections and Modi’s Hindu nationalist base are itching for a fight, while the new Prime Minister of Pakistan, Imran Khan, is close to the military leadership in what is effectively a garrison state where the army controls foreign and security policy. Stay tuned.
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