Geopolitical Developments: Europe Fears Another Crisis But The Markets Look Inward

Horrors across Western Asia and the fearsome toll this would take on Europe should another migrant crisis erupt are simply out of mind for the markets. The volatility risk premium points to a higher market over the next few days, while my technical reading of key stocks in the S&P 500 is bullish. There are several negative factors across global asset classes. Gold is signalling inflation fears. The action in currencies signifies $US strength. But taken together, the market looks set to overcome these concerns and rise moderately over the next few days.

A migrant crisis spurred by the disastrous Taliban victory in Afghanistan is again gripping European politics, as the once-shunned Belarussian President Lukashenko is fielding calls from Europe to save the continent from hordes of muslim migrants. At the root of this now-recurring problem is Middle East dysfunction, where economies are constrained and lopsided and politics opaque and autocratic. The Western temptation to disrupt the sanguinary status quo and install liberal democratic regimes is dead owing to the disasters of American intervention in Iraq and Afghanistan, but I see a deeper problem than resistance to liberal western values. At heart the Middle East has geopolitical power owing not so much to fossil fuels as to Pakistan’s nuclear capability, which has already destroyed the hope for non-proliferation since North Korea has largely benefitted from Pakistan’s assistance. Any attempt to move Arab or Iranian leaders to liberalize is rebutted by the fact the leaders can extract privileges and favors and band together by coming to the aid of Pakistan. Were Pakistan a growing and progressive nation then it would help the Great Powers to reform to Middle East since that would stabilize its own position and help foster economic growth. But since Pakistan is dependent on Middle East largesse the leaders have little incentive to liberalize and put their own positions at risk.

Contrast this with Latin America, which has long posed a geopolitical threat to the US because of perceived communist infiltration and the prospect of a migrant crisis. Along with military disasters American leaders also had political successes, moving most LatAm nations toward legitimate democracy and acceptance of free trade under WTO auspices. The reason why Latin America isn’t as bloody as the Middle East is the US moved many right-wing and left-wing leaders to embrace liberal democracy based on the simple facts that these leaders had no cards to play against America and could see the terrible results of autocratic and leftist policies. The region is not in good shape as the transition has been fraught and some leaders have retrogressed (e.g., Venezuela’s Chavez & Maduro, Nicaragua’s Ortega, Brazil’s Bolsonaro, Argentina’s string of Peronists) while COVID exposed their vulnerabilities, but it’s far better than the humanitarian disaster that is Lebanon, Syria, Iraq, Iran and Afghanistan. If Argentina and Brazil had succeeded in weaponizing nuclear power in the 1980s or had Cuba retained missiles in 1962, American liberal influence in LatAm would be effectively zero.

Unfortunately Pakistan isn’t about to change anytime soon. There are no workable solutions for Pakistan, only hoary calls from more democracy or the even more implausible scenario that Imran Khan gets the upper hand on the Pakistan military. To date Khan is being criticized on all sides, so the military is in firm command, as has been the case for most of Pakistan’s history. And its economic ideology is regressive, which explains why Pakistan is so poor despite being a nuclear state receiving large transfers from Middle East nations.

Dawn notes “One key indicator of the level of preparedness of a country for consistent, sustainable future economic growth is its progress in meeting targets of Social Development Goals (SDG). A reading of this indicator brings out a bitter truth for Pakistan — the country’s level of progress is just above Afghanistan and way behind that of India, Iran, Sri Lanka and Bangladesh.”

“The obvious answer is that governments fail to generate enough revenue which leads to a fiscal deficit and to manage this deficit they keep development expenses low and, worse, they even don’t mind reducing them at times of financial duress.”

“The level of seriousness of Pakistani governments towards expansion in the revenue base seldom arises out of their sense of responsibility towards what is right for Pakistan’s economy. It is often shaped by their short-term need to balance fiscal books — and gain some political mileage by implementing some politically-gainful, big-ticket projects. That is why the measures that are taken to broaden the overall revenue base often lack economic merits.”

Dawn proposes:

“But to make that happen, parliamentary democracy must be strengthened and economic policymaking made more inclusive with inputs from all federating units regardless of the political divides. And, annual development plans should not be the only item to be sacrificed during the financial crunch.”

This is a tried and failed nostrum that’s never worked not because people are unaware of it, but because the entrenched interests have other priorities. With the three major civilian power centers hapless against the military (e.g., Khan, the Bhutto-Zardari and Sharif families) what Dawn is effectively asking is for the military to give up its privileges and its economic agenda, which is absurdly unrealistic. The one catalyst for change would be a vastly superior India, which could move the Pakistani people to demand revolution out of the powerful emotion of envy. But for this to happen, India’s violence prone right-wing leadership would have to economically liberalize and build a manufacturing economy that India has always lacked. A manufacturing economy has the benefit of employing modestly educated workers and raising their living standards. But to date India has been a services exporter with relatively little competitive manufacturing ability.

Two former diplomats in The Hill note: “For example, India’s second-largest export is pharmaceuticals. The service sector, driven by IT and software development outsourcing, has cooled slightly during the pandemic but continues to shine as a growth area as India’s over 1,000 universities churn out more than 1 million engineers per year. Precision manufacturing of products like semiconductors is a natural evolution for what is becoming a high-tech manufacturing giant.”

Should Prime Minister Modi liberalize employment, FDI and trade rules and invest in making India a chip manufacturer to rival Taiwan, that would spur broad-based economic growth that transformed India and moved it out of the middle-income trap. I doubt this will happen but it represents the best hope for changing Pakistan and consequently stopping the bloodletting and suffering in the Middle East.

My current market positions include a large cash position, and the following holdings: Activision (ATVI), Amgen (AMGN), Apple (AAPL), Johnson & Johnson (JNJ), 3M (MMM), Pfizer (PFE) and a small net long position in S&P 500 (the levered inverse ETF SPXU and levered ETF UPRO).