The huge political and economic shifts taking place amid US President Donald Trump's global trade war, turmoil in the Middle East and the ongoing Russia-Ukraine conflict is putting geopolitical risk front and center of investment decisions. JPMorgan, for instance, has just launched a Center for Geopolitics, as companies become more reluctant to simply rely on business models and financial experience.
Marko Papic, chief strategist at BCA Research, an independent research group founded in 1949, joins John Lee and Katia Dmitrieva to give his take on the consequences of such significant global changes and how investors can best navigate these turbulent and uncertain times.
Geopolitics has increasingly made its way from academic and government circles to boardrooms and investor portfolios. Advisors and economists have always had to factor in political risk to some extent, but the past decade of trade disruptions, conflict, and a COVID pandemic have prompted a lot more attention to this area.
JP Morgan recently launched its Geopolitical Unit, and CEO Jamie Diamond issued a warning that geopolitical risks are currently the most important to watch, and we're seeing that play out in real time with President Trump's trade war fracturing global commerce along strategic lines.
You're listening to Asia Centric from Bloomberg Intelligence and Kadidum Treva in Hong.
Kong, and I'm John Lee also in Hong Kong, and today.
We're talking geopolitics for investors, the emerging world order, the biggest risks ahead, and perhaps areas of opportunity. Helping us to unpack all of this is Marco Pappitch. She's Strategistic BCA Research. It's an independent research firm. He's also author of Geopolitical Alpha, so the perfect person to kind of walk us through all this.
Welcome Marco It's such a pleasure to be here with you, Katya, and also John. John and I were colleagues before, and so it's nice to be on the same podcast with you as well.
Marca, it's great to.
See you again reunited. Shortly after recording this episode, Israel launch strikes on Iran. Iran retaliated, and the two countries have been exchanging missiles ever since. President Trump has found the flames, calling on Iran's unconditional surrender and threatening the country's leader. It seems things are only escalating. There's a human tragedy here with civilian casualties and the risk that this conflict widens. And for investors trying to navigate this landscape, uncertainty just waste a whole lot. More So, I called Marco again to get his thoughts. Marco, how should investors be navigating this? One would assume you know long oil, But how are you thinking about this?
Yeah? I think that oil prices did not really have any premium regarding this situation. And the risk now, of course, is that Iran retaliates in a way that's relevant to global supply of oil. Now that that's going to have to be more than just Iranian supply being taken offline, either by Israel or by the US, or by Iran itself. It really requires Iran to cross the rubicon of retaliation and try to interdict oil transitting through the Straits of Hormuz or directly attacking energy facilities in Saudi Arabia, Ua and elsewhere. So really the catalyst for a significant increase in oil prices from here has to be Iran itself deciding to retaliate outside of the tunnel of what has effectively been acceptable retaliation from the perspective of the market, which is retaliating against Israel.
Can you walk through some of the potential outcomes here and what you think as an analyst is most likely to happen.
So there's a couple of scenarios that can happen. One is let's say the current trajectory continues, Israel and Iran attack each other. Eventually Israel declared's victory, declares its operation over. Remember Benjamin Atnaku did say that this was going to last about two weeks and that the purpose of this is to degrade Iran's nuclear program sufficiently set it back by a lot. That's successful. I mean it's being accomplished. Even if a FOURDO facility is not completely destroyed, there's other ways to imperil to the centrifuges inside of it, And of course other components of the nuclear program, including its human capital in terms of scientists, have already been impacted. So that's one in which case, you know, oil prices are not really going to go up much more, and you know, obviously this becomes kind of a geopolitical nothing burger. The second is that US does get involved, particularly by attacking Foordo. At that point, Iranian leadership has to make a decision do they start attacking global supply of oil or would they simply retaliate against the American military basis, which carries with its other risks as well, but I think less so than going all the way. And then finally there's that third scenario in which Iran goes all the way, responds either to American attack against Florida or some sort of a wider American campaign against energy facilities, nuclear facilities in Iran, and tries to interdict the straits of Remus. What are the probabilities of all of these? I think the last one, where Iran attacks straits of Rumus. I think the probability of that is somewhere around twenty percent. Now, why so low? You know, why so low when the regime seems so backed up against the wall. Were two reasons. First of all, we have forty six years of empirical data for forty six years during which Islamic Republic of Iran existed. They've only really attempted to ever so slightly interdict shipping through the Straits of Romus once, and that was by mining the straits very tentatively. One of the mines ended up hitting an American naval vessel in nineteen eighty eight, and this led to the Operation Praying Mantis, where the United States of America absolutely decimated Iran's navy and attack their energy facilities in karg Island. So, in other words, the reason Iran has never done this other than that one time is because it's such a one or a zero. It's such an asymmetric tool. Once you do it, you invite overwhelming American response against you, and that's very dangerous for Iran because there's no really way for them to defend themselves against the US. So what this means for investors is that it's very dangerous to go against the current momentum. I think oil prices have more room to rise from here, but ultimately it's a temporary rise because Iran cannot permanently close the straits for moose and once they pull that card, once they pull their card, they'll invite retaliation from the US with such an overwhelming force that they would not be able to close the straits for a prolonged period of time, in which case any move in all prices. Almost the higher the AILL prices go, the shorter they can stay up there because Iran loses its capacity to really affect anything. Their military will be degraded massively.
I'm just pulling up where oil prices are right those.
Second seventy five I think Brent.
Yeah, seventy five. So we see Brent at seventy five today Wednesday morning. Where could we go from here?
Well, I think that we can easily be at eighty, very easily. We could be at eighty dollars, eighty five dollars sort of. From here to eighty five dollars, you don't need something straordinary to happen. But for us to go over one hundred dollars, I think it will require Iran to clearly start attacking outside of Israel, outside of US military bases. For oil to get to one hundred dollars and above, you would have to have Iran start attacking shipping in the Straits of Muz, interdicting shipping, perhaps attacking Saudi oil facilities. Again, there's a reason they haven't done that since well, really nineteen eighty eight, but even then it was very tentative. There's a reason that the Hutis, who are aligned with Iran, have not attacked Saudi Arabia over the past two years. Since October seventh attack on Israel, Houtis have been very active in the Red Sea, but they have not sent any of their drones north because Iran and Saudi Arabia also have a detent that's worked really well for both of them. So a lot would have to change. And of course, at this point, you know, most investors are commentators simply say, well, Mark, there's a lot going on. I mean, like there's regime change in Iran, to which I would say, there's really only one case I can think of of regime change from the air. You know, you can't land in F sixteen in Iran and impose regime change. That's not going to happen. Israel is not going to cause regime change in Iran. The only time that air strikes caused a regime change was actually in my home country of Serbia. Nineteen ninety nine. NATO attacks Serbia for three months. Eighteen months later there were protests on the streets and Slovana Milosho, which was overthrown. You could argue that that was connected to the air campaign, but it's very difficult to create regime change when there is no revolutionary group on the ground that you're actually helping, and when the regime is very very comfortable shooting people in the streets. You know, I don't think that the Iranian regime feels as backed up against the wall as perhaps some commentators have, which would prompt them to say, okay, well, then in this case, let's pull out the nuclear option and I excuse upun Obviously it's not a very good one, but for Iran it is the nuclear card. If they end up choosing to interdict shipping through the straits or removes, it will be as if they were attacked by nuclear weapons. Because the a S symmetry between Iranian and American military capabilities. The golf is huge, and we know this now because we've seen how far behind Israel they are. Their order of magnitude even more behind the US because one thing Israel doesn't have is strategic strike capacity. They're attacking Iran with fighter jets. The US has strategic strike which means that they can deliver a lot more payload per flight in the US case.
Marco, is there anything else we should be thinking about here?
Well? I think a couple of things. One, how much munition does Israel have to keep the conflict going? We know how much munition Iran has. He has somewhere between two thousand and three thousand ballistic missiles. It's probably down a quarter or a fifth of that supply, So maybe Iran has enough ballistic missiles for another five to ten days. But how many ground attack missiles does Israel have? Because you have to understand, Israel does not prepare itself to affect regime change in a country of ninety one million people's that's not what Israeli Air Force is designed to do. And so when Prime Minister Natanyahu said that this operation would last two weeks, I don't think he just pulled that number of thin air. I think that he based it on the ability of Israel to you know, continue the operations based on their munitions, and so I do think at some point the United States of America will have a pretty significant lever where they can direct where this goes by basically telling Israel, look, this is sufficient. So that's the first thing I would say. The second thing that I would say is just a big picture takeaway from this is you know, where's Russia, where's China. Yeah, we've now listened for two and a half years about this sort of fear mongering that the West is behind, that the West is critically low on munitions, that Javelin supply has run out. What we found out over the last five days is that basically Russian surface to our missiles, the S three hundreds are trash, not very effective. And that was like the big thing that Iran had, it had the sophisticated Russian surface to our missile system that apparently is trash. And then the second thing we found out is that China really like, there is no China block, There is no part of the world that's allied with China, because you know, China is supporting Russia. The way that India is supporting Russia. They're buying oil. They haven't supplied Russia with military. Anybody who says differently is just not saying the truth. China supporting Russia with electronics. If you open up a Russian drone, you'll find a lot of Chinese components in it. But if you open up a Ukrainian drone, you will find a lot of Chinese components in it. So this is nonsense. And finally, here's Iran, which is supposedly in some sort of a Chinese sphere of influence, and there's absolutely no help coming from China. And so that brings up the question, you know, is the world really descending into a Cold War? Is this really a bipolar world when this supposed access between China, Iran, and Russia is you know, it doesn't really come close to any of the other axes that we've seen over the past one hundred years.
Yeah, it's a good point, and it lends itself to this idea of entering multipolarity as opposed to going back to the Cold War era exactly.
In fact, you could argue that China in the US are on some level even aligned in this particular situation in fact, if Iran were to cross that redline that I'm saying is, you know, kind of their nuclear option, which would be to interdict shipping. The country that they would be hurting, perhaps the most is actually China, because China sources its energy from the Middle East, which then begs a very interesting question. You know, it's a geopolitical paradox. American taxpayers in American Navy are protecting China's access to critical natural resources in the Prussian Gulf, and so in a way, by being very firm against Iran and by warning Iran not to strike shipping in the Straits or Fromoos, the United States is protecting China, and so I'm not you know, it's a very strange situation where the two superpowers that are apparently, you know, sort of dividing the world into two on some issues, including important ones, are quite aligned.
Yeah, there's like e ven diagram and we're kind of in the middle right now.
Yes, that's a great way to put it.
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Now back to the recorded episode, Marco, we've been hearing a lot of our geopolitics japing Morgan open this arm. Bloomberg has a geoeconomics unit as well. I guess, just for listeners, if we can take a bit of a step back, how is this analysis unique or different from perhaps what an investment advisor or an economist would normally do because they also look at current events and politics.
Well, yes, buddy, look at them as exogenous factors. I think that's the difference. If you're an economist, you believe that economics is going to help you predict inflation and growth, and then with those two variables, for the most part, you can determine act allocation on a pretty wide variety of time horizons. Somebody who is focused on geopolitics in the markets believes that geopolitics is not exogenous. In fact, it in many ways underpins the very growth in inflation forecasts, and in fact, you cannot just use economics, which first and foremost is not a science. It's not a natural science, it's not physics. It is a social science as much as any other social science. It's just a little bit more quantitative, and so effectively, you take politics in geopolitics seriously as inputs, not as surprises that upend your model.
So they're not external risks, they're kind of the core of what you're looking at. So how would the outcome, I guess be different, Like, is there an example of that where an economist might look at things like GDP CPI and say, oh, while the external factor is perhaps trade frictions versus what something like, what you would do?
I think the pandemic is probably the easiest way for me to explain the difference. You know, economists have been dumbfounded, confounded by the resiliency of both acid prices, the stock market, the rally, but also of the economy, and anyone who takes politics seriously is not because we effectively swung the political zeitgeist, swung away from prudence, from orthodoxy, from what we have dubbed the Washington consensus. We swung very hard to something else. And that happened pre pandemic. By the way, that happened before the pandemic. Austerity led to secular stignation. Secular stignation low growth and low inflation was not an economic phenomenon. It was a political phenomenon because household balance sheet repair was made more difficult bi austerity that prolonged the pain that led to anti establishment political outcomes such as Brexit and Donald Trump. And then what happened was that fiscal policy became a lot more pro cyclical. And we got the first taste of that in twenty seventeen with the unfunded tax cut, and then the pandemic hit, and then really the wheels came off, and the fiscal policy that occurred in twenty twenty twenty twenty one was meaningfully different from every other fiscal policy that we've had, really maybe in history. And so a lot of the Microsoft Excel models were basically telling you that there was going to be a pendulum swing the other way with fyscal thrust becoming negative. But actually that never happened because that fiscal policy remained on the balance sheet of households, It remained in the multiples of various companies and it suppressed savings trade due to psychological sociological effect and ultimately led to where we are today, higher nominalo GDP growth, higher inflation, also less precautionary spending, more yolo ing, and so on and so on. So that's I think the best thing is now, Marco.
The traditional approach by investors when they look at geopolitical risk has been to bring in like an ex politician, an ex government official, to try to get some you know, inside scoop on what's happening with geopolitics. But you take a quite a different approach. You take a constraints based mythology. Could you go through that with us?
Well, I have a lot of respect for Jamie Diamond. You know, he's the CEO of course of JP Morgan, and he's, you know, all power to him. However, I think that the new unit that they're setting up over there does not actually add much to analysis, you know, just create well yeah, I mean creating an exogenous unit like an Institute of Geopolitics is just going to produce some glossy PDFs that we're all going to read with really fancy diagrams. Doesn't mean that JP Morgan as a financial institution as an investor, institution is going to adopt geopolitics at the very core. And this is why John, I focus on a framework that doesn't require you to wheel in a past expiration date policy maker into your boardroom. You know, this is very, very critical because geopolitics and politics is too important to be outsourced. You're basically outsourcing your fiduciary duty. It's your job to analyze politics in geopolitics. It's not somebody else's job because they don't know your portfolio, they don't know where you're exposed, they don't have time in that one hour they're going to spend with you to do this, and so you need to learn how to analyze it yourself. And so yes, I generally dismiss the usefulness of politicians, ex policy makers, ex members of the state department or whatever. You would not hire an ex CEO of a telco company to analyze telcos. You would train an analyst on how to analyze telcos, just like you wouldn't really take a quarterly CEO, you know, presentation seriously. I mean they're going to be selling their book. Obviously. Similarly, we don't sit around and like take what policy makers say as given. I think that there's value, there's value in expanding our horizons listening to a lot of different viewpoints. But notice that most of the hiring at these institutions. When financial institutions decide to create a little pet project of a like institute for geopolitics, notice that the hirings are almost exclusively out of the Western realm. So how is that going to help you analyze China? Why don't you have ex Chinese premiers or vice premiers as members of these institutions. Why don't you have a former prime minister of a mid level power like Indonesia or Malaysia. In India, it's almost exclusively former politicians in the West. And I think that's not helpful at all.
So you're basically saying that these kinds of analyzes should really be made at the core of a bank or financial firm, like it needs to be integrated into all of the investment or economic kind of research functions.
So Katcha, I think you've nailed it. I mean, you asked at the beginning, what is the difference between my approach and that of everybody else, like economists or people who are much more focused on traditional tools and I would say that my approach is the one that investors have used throughout human history. Everybody else is using an anomaly that's only worked for the last forty years. In other words, most investors throughout history have incorporated geopolitics and politics at the very beginning of their assembly line. It's only after the nineteen eighties where two things happened. One Cold War started to freight, Soviet unions started to lose. I mean that was what gorbe which have effectively said like, look, we give up. And then also les I fair capitalism one. The Margaret Thatcher and the Ronald Reagan revolution gave us this kind of like les a fair view of the world. And those were two things that combined together on domestic political front and geopolitical front to make us believe that to be a professional investor, you don't have to know what the Senate does in America. That you don't have to know why Romania wants to be in NATO, that you don't have to know the geopolitical significance of Malaysia. You know, you can just be ignorant of these things that you can be a professional investor. You just get your CFA, maybe you go back and get your MBA. You're good. Don't worry about any of this other stuff that's nonsense, you know. And so that's the difference. Like the fundamental difference is that if you actually look at history, most astute observers of markets were actually quite geopolitical, you know. I mean, I think about, for example, people like George Soros when he broke the Bank of England. Guess what he didn't do. He didn't waste money trying to break other central banks in Europe because he knew that the Bundesbank would support these other banks but would not shell out to cash for the British pound, because hey, that's up to the Brits. The Rothschilds now Ferguson, of course, one of the prost pre eminent historians we have today. His PhD dissertation was about how Rothschilds became the family that they are, and it had to do with their correct read of Napoleonic warfare and when to basically lend borrow based off of that conflict. So geopolitics and politics has always been part of our arsenal. We just have stopped using it, and I think it's time for us to take it seriously again, not outsource it to retired policymakers or policymakers who have to be in the private sector for four years because they lost an election.
So Marco, how is your approach, hoped you in navigating US tariffs and in particular deciding whether Trump will implement his tariffs or not.
Well, first of all, what is the framework, right John? I mean just to you mentioned it, you hinted at it material constraints. I mean, very quickly, I couldn't care less what politicians say. I couldn't care less what they believe in or what they want.
So like the constant stream of truth social posts.
Yes, the cost is stream of through social posts. But also this is important because a lot of consultants in the political risk space will sell you their access to policymakers. Yeah, you know, go look at my rollodex. You should wheel me into your boardroom because you know, I know these people, and the truth is that can sometimes be useful. But you don't have a lot of time. You know. Look, if I had all the time in the world and all the resources in the world, I would be the CIA, and then I would tap your phones and I would know exactly what you're going to do. But because most investors don't have those resources, I would say none of us have that. We need a shortcut. And so what is the shortcut? The shortcut is a framework that I've developed over many, many years, and it harkens back to like pure geopolitical analysis that I learned in political risk industry. So it's not just like I invented it like sitting around smelling flowers one day. It has to do with this very quick notion that preferences of policy makers are optional and they're subject to material constraints. This is true in life too. You both have many preferences, but they're optional. You can or you don't have to act on those preferences, and they're bound by the material reality in which you live. But material constraints are neither optional nor are they subject to preferences. For example, I'm a forty three year old father of three. I would love to dunk. You know, I would love to dunky basketball.
Yeah, we remember you liked VNBA.
That is my preference. That is my preference. However, the material constraint is that I can't wish away the fact that I am six foot one, forty three year old with an acl repaired NI. Those are realities, and so it doesn't matter what your preference is, it's always the best. That's right. How does this help me with something like Trump? You just ignore the preferences and the question what does he want? I don't care? Is the correct answer. It is more what can he accomplish given the array of material constraints. And one thing that I think is interesting is we as a financial industry, we in finance, us, all of us, you, John, you caught your knee, We're actually more than qualified to assess using a data driven approach how powerful these material constraints are. So we don't actually need all these expulse makers to come into our office and say like, well you know what, No, I don't need you. I know how bond yield works and how vicious it is as a constraint on policy maker behavior.
Well, let's dive into some of those constraints you just mentioned the bond yield. Are there other constraints like the things that would be just a wall that Trump cannot blast through? Because the thing with President Trump is that he kind of goes past or blasts through a lot of constraints. Right, He creates a new reality. So I wonder if you can talk about some of those very real constraints. I think last time we spoke you mentioned elections, for example, and voters inflation. So what are some of those elements.
I So, one slight disagreement with Chikatia I would have is that he always hints that he's going to blast through them, or he does for a very temporary period of time. President Trump is really good in making you think that he doesn't care. Like that's his genius, right. So April second is a great example. He's got Secretary of Lutnik holding a plastic bulletin board that was produced by Chad GPT. You know where they like taxes and penguins. A lot of my clients email me or call me and they're like Marco, like what constraints these guys are putting tariffs and penguins. They don't seem to care about anything. So he's very good at that. But in terms of what are the constraints, I think first and foremost is the bond market. Bond yields never responded to any of this volatility in a way that I think they would have hoped. You know, this is a Bloomberg Podcast, So we don't really have to discuss that in depth. Everybody understands how bond yields work. But I think an interesting part of all of this is that in any game theoretical confrontation between two sides, such as let's say China US and trade or Europe US and trade, it's not just about who's more powerful, it's also who has risk tolerance. And I think that what most commentators just don't understand is how little pain tolerance, risk tolerance American households have. They don't want the trade war. This is definitive. You can go to Ipsos, you can go to Reuter's, you can go to Gallop. They're all very very clear that out of all the issues that matter to voters, trade, tariffs, globalization is the least important. They don't want President Trump to focus on it by a wide margin. And the second issue is that the sentiment towards trade and globalization has massively increased positively in the US over the last ten years, and I would argue President Trump in many ways is to thank for that. And we can discuss how so, what I'm saying here is that the biggest constraint for President Trump is the median voter. If you're offside of the median voter, you're going to be absolutely crushed in elections, whether it's midterms, whether it's twenty twenty eight, so three years from now. And I don't think he's completely immune to this. The United States of America is not a kingdom. He's not a king. He has many stakeholders around him who have invested a lot in his presidency, and so I think that he's bound by what the median voter wants, and the median voter does not want global trading system to be reshaped overnight. It doesn't mean that President Trump's gut is in the wrong place. By the way, I do think the US current account deficit is way too large, but it's not going to be corrected over six months through egregiously painful recession or trade policy. He's going to basically negotiate deals.
I want to get it over to John because I know he wants to ask you a question about taco, but I want to add just just a really quick follow up. So you said it means that he'll have to negotiate for deals. So is that the implication?
Then?
If if Trump faces the constraint of the median voter. Then he'll have to come to the table and negotiate by lateral deals, and the tariffs will likely not be as high as Liberation Day tariffs.
I think likely is a poor adjective. There's no chance. Really, tariffs have no chance to be as high as Liberation Day. But but notice how very few of us discussed that ten percent across the board tariff. We just don't mention it anymore. And that is kind of the genius of President Trump. To be fair to him, He's made us, the markets, corporates, CEOs swallow a ten percent across the board tariff. So I do think that that will stay, and then individual deals with individual countries would lower other tariffs except sectoral ones. I think sectoral ones will stay as well. So I think investors are probably going to have to plan for like a twelve and a half percent Like if I was a casino and I was setting a line, you know, and you can take over or under bets, I would say twelve and a half percent across the board tariff, which is still in a massive increase in tariffs for the US. But you shouldn't think of it as some sort of a reshaping of global order. You should think of it as President Trump imposing taxes on American households, because he's effectively imposing a vat on consumption, Which goes to my point that I think the fiscal gravy train in the US is over and there's a hangover phase coming. And that's one example in which we're getting something that most investors did not expect.
Yeah, and as Kati alluded to, I am dying to ask you this question. Now. I love how the finance industry comes up with these creative phrases and acronyms. The beginning of this year was all about American exceptionalism and why you should be overweight US financial assets. Then there was like sell America trade when the tariffs came out. Now, the latest creative one is the Taco trade. And for those who don't know, it stands for Trump always chickens out. Now, this is this idea that investors should buy on weakness on the assumption that Trump will back down, and which would lead to a rebound in asset prices. And you saw that with China as well. What do you think of this trade markat.
Well, I think it's a pejorative term, you know, because I don't think he's chickening out. He's just producing a negotiated deal to his critics. Looks vacuous, you know, empty. But fourteen months ago I presented that same strategy to my clients. I just call it the seven steps of maximum pressure. I'll shorten it for you, guys. This is a thirty minute show. You know. The first step in my seven steps is that President Trump always asks for the moon and he wants you to pay for the escalator to the moon. And then six later he settles to the roof of his house and he'll bring the ladder. So is that chickening out? Well, no, because it's marginally positive.
He gets to go to the roof of his house out of the negotiation tactics.
You see, he gets to the roof of his house. He wasn't able to get to the roof of his house. Now he can. You know, he can sleep up there. It's cooler, you can watch the stars at night, you can watch the moon that you suggested you were going to get. So I don't think it's chickening out. It's just this is empirically backed. President Trump is not someone driven by preferences. He's actually quite I think, unanchored by his preferences. He's willing to try out based on material constraints, what's the maximum he can get from the rest of the world. And so that's how he's negotiated with North Korea, That's how he negotiated USMCA, he negotiated Phase one deal, he negotiated a rarer deal with Ukraine, the fentanyl tariffs against Canada and Mexico, and now, yes, reciprocal tarifts do. There's no surprise here. But I don't like saying chickening out because chickening out would mean going back to day one. And the truth is that he does get a deal done is just only marginally positive for the US. It's not like, you know, necessarily revolutionary.
Speaking of the rest of the world, you have this interesting view that we're entering a multi polar world, and in one of your recent research notes, you mentioned that a lot of your clients seem to think we're entering a new phase of the world where it's going to be bipolar. In other words, it's China and the US. But you say that's wrong, and this kind of global ordering goes back to I guess Kennith Waltz and the Theory of International Politics, which is kind of this seminal text, probably one of the most important texts and international relations. But I want to ask you, why is it wrong to think that we're entering a bipolar world? Why is the case now that we're entering multipolar state? I saw you pull a book out of your stack behind you.
Yeah, well, I think that No. Kenth Walltz is a great, great deep reference. Gotcha. I would say a much more readable and more updated view would be Mursheimer John Murshcheimer. Professor Murchscheimer is known for some of the controversies. He has very interesting views on Ukraine and so on. But he is actually the father of what we call offensive realism. And he wrote the book The Tragedy of Great Power Politics. And at the end of this book, you know, which is very readable. I would definitely encourage everyone to read it. He talks about these three different worlds that exist. There are three different ways that power is distributed on planet. Unipolar world is something we're very familiar with because we lived in it from nineteen eighty five. I would argue to sometimes in twenty ten and then a bipolar world. Of course everybody remembers because that's what the Cold War was. So here's China coming along, and so pretty much everybody in the United States of America, but I would say Western world broadly speaking, believes that, of course it's going to be a bipolar world again, We're going to have round two. But the reality is that if you actually look at history, multipolarity, which is kind of a free for all no one's in charge, is the most likely outcome. So in Meersheimer's work, he goes back to seventeen ninety two and he argues that basically a multipolar world was in effect for about seventy five percent of that time, and so it is sort of mathematically incorrect to assume that the world is just going to there's like a gravitational poll that will take us to a bipolar world. And everybody thinks that the world we're in right now where it's sort of not clear who's in charge or what the two spheres are. Everybody all my clients, like sort of sovereig wealth funds and pension funds. They keep telling me, Marco, we need you to do an Excel spreadsheet and put all the countries into two different rubrics. Tell us how does the world split up? And I'm like, it may not. Out of ten years in human history, eighty out of one hundred years, the world just remained messy, you know, and it was kind of a free for all. So we should probably given just simple probabilistic math, expected to stay like this.
And Marco, if you put this into investing, most asset owners are still heavily overweight US assets. So if we move to a more of a multi polar world, we also see this in terms of the flow. Do you think the weighting of US will come down in things like NSCI world.
So now we come full circle and we made fun of President Trump a little bit. But here is where President Trump is actually not misaligned, and I think he gets a lot of criticism. So why do I answer your question by referring to the president? Because you can think of geopolitics and macroeconomics as hardware and software. So I would say that the planet Earth has bought some new hardware. Geopolitics is hardware. It is the world we live in, and we have abandoned the unipolar hardware. We've installed a you motherboard. It's a multipolar one. But We're still running an old operating system on this hardware, and it's the unipolar operating system. We haven't upgraded, we haven't downloaded and installed a new one. Why do I say that, Well, because America has this enormous current account deficit. And this is where President Trump talks about trade imbalanced current account imbalances. Okay, the reason it doesn't make sense for America to be a consumer of last resort is because it's no longer America's world. Why should it, you know, when it's a unipolar world and no country dares challenge the hegemon with preponderance of power. Of course, you're going to let the Chinese send whatever product they want because you're in charge. And eventually China will be Wisconsin, which is kind of what everybody thought in the nineteen nineties. But the challenge is that once the world becomes multipolar, it's not that America is mean, it's that America is no longer magnanimous. It has to be more machiavellian. It has to think a little bit more seriously about who accesses American markets. And so President Trump is not incorrect to focus on narrowing that current account deficit. However, and this goes back to that amphitheater we all sat in when we were nineteen years old. What is the flip side of a current account. It's the capital account. So if America successfully narrows its current account deficit, and I don't think it's going to get into surplus ever, and President Trump doesn't want that, but as this enormous current account deficit narrows over the next five years, capital account surplus has to come down. So America hasn't just been a consumer of last resort. And this is where President Trump and his various economists who work for him, like Steven mirran I, would take issue with them. They keep indexing on the current account deficit, but they don't talk enough about the capital account surplus of America, which is a benefit. America is like the world's sovereign wealth fund. Everybody sells to America takes the money they make reinvested in America. I mean, there's benefits to that. The problem over the next five years is that as American current account deficit narrows due to this software update for the new hardware, I do think they'll be capital lot flows. This isn't the end of America. It's not the end of exceptionalism, it's not the end of innovation. It's just a transitionary period during Yes, I want to be on the way to American assets, that's it, yep.
And at the fringes, they'll be less demandful of, say American treasuries.
Naturally, because in a multipolar world, John right, it's not that America loses reserve currency status. And by the way, the United Kingdom, the British pound remained both reserve currency and was used in financial transaction even as the United Kingdom actually had a current account surplus. So America doesn't have to be permanently in a deficit, it doesn't have to lose reserve currency status. But yes, I do think reserve currency role will be a little bit more multipolar. My dear colleague and friend, Juan Correa and I just published a report in this and I actually really really believe this thesis, and I think that if you're a long term allocator of capital, you have to stop thinking in terms of end states. It's not about what world we end up living in, whether it's bipolar, multipolar, or unipolar. Where should you put your money? Where there's technological innovation and productivity, that's never going to change. But in a transition between end states, that's where geopolitics will have a huge implication. And so there's this very incorrect question that I think a lot of stick it investors keep asking what kind of a world am I going to live in? And what do I do? Then nothing, You're just going to keep being hit in fastor The issue is that from here to there, that transition itself will lead to capital relocation and out flows, and we have to brace ourselves for those five six, seven years, during which yes, I think American aasists will want to perform.
Before this podcast, I was two and a half back to the days when we actually worked together. That was like eight years ago, and I know we're aging ourselves here, but I remember one of the big trades that you were espousing back then is defense. Docs Now, you were pretty early on and you were talking about how we're entering into a multipoler world and you're talking about the need for countries to spend more arming themselves, and this has really played out. I think defense is the number one performing theme based on our analysis. It's outperformed things like artificial intelligence. Do you still think this trend's still going to happen.
Wow, that's a really really deep reference there as well. John, thank you. We started working at eighteen together, so naturally we're twenty six. Oh it doesn't work. I already said I was forty three. So yeah. So what I would say about this is, I do think innovation in defense space is going to be huge. But you got to be careful now, right, These stocks have gone up a lot, and the only way to play this thesis and this theme is to buy the incumbents. But I think there's going to be a wave of extraordinary innovation. So if you look at what's happening in Ukraine, Ukraine and Russia are now the world's greatest innovators when it comes to drone warfare, and a lot of their drones are very cheap. Ukraine deployed drones that cost four thousand dollars in its recent June first attack on Russia. The average cost of America's most popular drone, which I still believe is the Reaper, is thirty million dollars. So when you start thinking about, Okay, where do I want to put the money, I think the defense the public stocks may have gone up as much as they can. I think that now is the time to start looking at venture and private equity private markets as an investment thesis for sophisticated institutional investors, because there's going to be a massive disruption. And by the way, not all of this technological innovation is going to lead towards AI. I hear this a lot o AIAI No. In many ways, for military technological innovation, you're going to have to go backwards in terms of technology. So Russia has deployed a drone that's tethered with a fiber optic cable. I don't know if you're aware of this, but one of the greatest innovations over the last three years on the Ukrainian battlefield is that the Russians have a drone that's connected with a cable. Well, why because it avoids countermeasures designed to disrupt the electronics. When you're tethering a drone with a cable, you can effectively avoid jamming. And so, you know, don't assume necessarily that the public market stocks are going to be the ones that are going to be the best, because a lot of the incumbents, I think in the defense space have learned to kind of taste the sweet nectar of government profligacy, and they're not at all prepared for the kind of technological innovation they'll have to bring to the table to compete with some of the new incumbents. Great.
Yeah, this is a good point to leave off on. It's been a really interesting conversation. Thank you so much for joining us today, Marco.
It's a real pleasure. Cutch in, John and I hope to maybe do this in person next time. I'm in Hong Kong, looking.
Forward to it.
You've been listening to Asia Centric from bluever Intelligence. I'm Kad Dmitrieva and I'm John Lee.
You can listen to all our episodes on Apple Podcasts, Spotify, or wherever you listen. And this podcast was produced and edited by Clara Chen.
Thanks for listening, See you next time.