Long Read

Storms Gathering in 2019

The Iran nuclear agreement (JCPOA) is on life support and could collapse next year, but a military conflict is not inevitable in 2019.  China’s resentment of US economic demands is growing, but it still needs good ties with US to bolster innovation.  Declining Russo-US ties will continue, endangering if not putting paid to a renewal of the New START agreement which expires in early 2021, shortly after the next US presidential inauguration.  Europe risks a further decline in international clout unless it can overcome internal divisions.  Brexit will weaken the EU but not as much as it does Britain.  Slow, uneven progress in North Korea will be a relative bright spot.  Geopolitically, we are slipping into a bipolar world pitting Russia and China against the West, increasing the scope for violence in the Middle East and elsewhere.  It will take leadership on all sides to avoid a new bipolarity.  It is hard to see who or what will stop the drift.

Economically, there will be slowing growth, with all the key global drivers of economic growth struggling to one degree or another.  The US is coming off a very good year but faces rising deficits, higher interest rates and uncertainties related to Trump’s anti-Chinese policies.  European growth may already have peaked in 2018.  Italy, Brexit and a slowing Chinese economy could be further brakes.  The Chinese government is determined to keep up growth, but further inflationary measures will add to the worsening debt problem.  Faltering ties between Xi and Washington hang like a black cloud over its economic prospects in 2019.  A China hard landing in 2019 would send the financial markets into crisis, potentially doing permanent damage to emerging and developing country economies.

Major Risks in 2019

1.    Increasing Sino-US Tensions Up to a Point in 2019

Beijing’s hope for a more comprehensive deal on trade and investment with Trump at the recent G20 meeting in Buenos Aires was not fulfilled, but the two sides negotiated a timeout on any more US tariffs, including increases on existing one, until after the New Year.  In return, Beijing has promised to buy more US agricultural goods and energy.  It is doubtful the truce is anything more than temporary.  Putting pressure on China has bipartisan support given the widespread fears of China becoming a peer competitor on technology.   Before the 2020 presidential campaign gets underway, Trump will need to show that he can get major concessions on issues that matter to US businesses and the foreign policy elite, such as China’s IP theft and greater access for US and Western investors in Chinese sectoral markets.  The US is stepping up efforts to dissuade its European allies from doing business with Chinese technology giants, such as Huawei.  China may hope that the clock runs out on a Trump presidency before it has to seriously consider structural changes to its state-heavy model, but a united US, European and Japanese front—which seems to be developing—will make biting the bullet on liberalisation—difficult to avoid.  More investment controls by US and Europe are already being put in place and even if a deal is reached soon will not be disbanded.

The stakes for China are high.  Beijing realises it still needs to train scientists in the US and learn from US technology firms.  Beijing’s dream of a high-tech China could be slowed or pushed off course if Sino-US ties take a sudden dive.  Xi’s recent narrative pre-empts that outcome in political terms, by focusing on self-reliance.

Beyond the immediate crisis, the groundwork is being laid for more Sino-US confrontation and possible conflict.  You can see the narratives already forming.  For Americans, it revolves around “China owes us.”  China would never have risen without the US allowing it in the WTO and opening the global trading system.  That, of course, ignores all the benefits that the US derived from China becoming a global economic driver, including in preventing the West from slipping into a deeper recession after 2008.  On the Chinese side, there is an even more deeply rooted assumption that the US would stop China from rising at some point so as not to threaten the US’s global position.  Trump’s talk of punishing China feeds this deeply ingrained belief.

2.    More Crises in Europe, but Maybe a Glimmer of Sunshine?

Italy is a paler version of Greece but, as one of the EU’s founding states, much more difficult to handle.  Despite being Europe’s third largest economy, Italy looks set to decline, with its best and brightest departing for Germany and other EU countries.  The new populist government has shown a determination not to rein in higher budget deficits, putting it at odds with the EU Commission.  Forcing austerity on Italy will be politically harder with the potential for triggering a bigger crisis and fuelling an Eurosceptic backlash across Europe just months before the May EU parliamentary election.  Striking a compromise with Brussels—that looks more likely in recent days—could defuse tensions, but unless Italy goes back to undertaking structural reforms, it is just putting off the day of reckoning and for the EU, an even larger euro crisis than in 2011.

Brexit—“no-deal” or not—has already hurt Britain’s economic performance.  The uncertainty over its future trade ties with the EU—unlikely to become clear for several years—will most likely be a further drag.  Neither the Tory or Labour party have been able to respond to public opinion which has been moving against a sharp break with the EU.  British politics looks overdue for a realignment with a Tory Party split now possible.  With such a weak and distracted Labour leadership, it is unclear whether they could exploit it.

A strong showing for the Far-Right in the EU parliamentary elections would be a blow for Macron and Merkel who have tried to put momentum behind a stronger EU.  Macron faces growing popular dissatisfaction, although parties on his left and right have still not recovered from their defeat at his hands.  The loss of public support inside France does not help his campaign to defeat populism and nationalism in the rest of Europe.

Macron also faces a change of leadership in Germany.  Even if Merkel remains in place for the rest of her Chancellorship, it is unclear how valuable her rhetorical support will prove for his efforts.  He could work with two of the three leading candidates he could work with.  CDU secretary general Annegret Kramp-Karrenbauer is closest to Merkel.  Former CDU faction leader Friedrich Merz, a social conservative with strong anti-immigrant views, has voiced support for Macron’s ideas for reform.  This may change if the CDU under him goes into a coalition with FDP which is strongly opposed to Macron’s ideas for internal transfers to stabilize the eurozone.  Health minister Jens Spahn—who has been down in the early polling—is also strongly opposed to eurozone reforms as well as being a critic of Merkel’s pro-asylum policies.  It may take months for a clear picture of German politics to emerge.

Over the horizon, the election of Donald Tusk as Polish President in 2020 could help tilt the balance in Europe away from populism.   Yet strong anti-EU sentiment—albeit in the minority—is now dug-in and is a political factor going forward, impeding reform efforts.  An introspective Europe is weakened on the international stage.  Pro-EU leaders already suffer from dealing with a US President who does not see much point to the EU, if not NATO.  Increasingly, Europe is dwarfed by Trump, Xi and even Putin who are re-shaping international relations to favour strong leaders and unitary states, away from multilateral and regional institutions.

3.    A Politically Dysfunctional US

Now that Democrats have taken over the lower house, there is a chance that Trump could be impeached, especially if the Mueller investigation has proof that the Trump campaign colluded with the Kremlin in 2016.  In most cases, Trump will be safe from removal because that requires a two-thirds majority in the Senate.  However, should there be a serious charge of Trump being personally involved in criminal behaviour with Moscow, a Senate trial could be close-run thing, splitting Republicans and paralysing the presidency.  A split Congress will impede domestic legislation, but the President has more say on foreign policy and an impeached but not indicted Trump is unlikely to change course.   He could even be more aggressive on China where there is bipartisan support.

The fiscal outlook is key weakness going forward for the US.  The 2017 tax bill reductions may have spurred a rebound, but most economists believe it will be short-lived.  Despite the Trump Administration’s confidence, the US economy has been settling into a lower band of average annual growth—closer to 2.0-2.2%—rather than the 3%+ that the President is counting on.  Meanwhile, the annual deficit is rising at record speed.  Under even the most optimistic forecast, Federal debt rises to a dangerous level of over 118 percent of GDP in 2038.  Alternative scenarios—which some experts believe may be more realistic—show even larger annual deficits and overall debt up to as much as 165% of GDP by 2038.

It is not as if the structural reforms needed to bring down deficits will be easy.  The US already overspends on healthcare even before the vast majority of the baby boomers have retired.  As shown by the polemics over Obama’s Affordable Care Act, it would be politically difficult for either party to radically reform the healthcare sector.  In the medium term, the US looks stuck with its 18%+ of GDP going to healthcare, almost twice what other advanced economies pay for it, some with better results.

4.    No Option but China for Putin

Many Russians worry about overdependence on China, but Putin has no alternative.  If the Mueller investigation proves there was collusion between the Trump campaign and Moscow, not only will it boost chances of Trump’s impeachment, but US ties with Russia would take another hit with a new round of sanctions and more pressure on Europe to cut its dependence on Russian gas.  Europeans are unlikely to kowtow to US demands on an energy cut off but won’t weaken existing sanctions against Russia unless Moscow makes concessions on Ukraine.  With hardliners (not Trump) in charge in Washington on Russia policy, there’s little chance now for the New START treaty to be renewed or the INF treaty repaired.   Domestically, Putin’s star is waning, but it’s unclear whom he believes can be entrusted with leading Russia after his term expires in 2024.

5. INF Withdrawal Opens Way to An Arms Race

Trump’s decision to leave the INF treaty was as much motivated by Russia’s violations as by concern that China has largest and most diverse missile force in the world, with an inventory of more than 2,000 ballistic and cruise missiles and Beijing is not bound by the INF or any other treaty.  US military fears about China restricting access and making it harder for the world’s most technically sophisticated military to have free rein everywhere have been growing for many years.  Trump’s increased military budget—after years of sequestration under Obama—means that the military-industrial complex is back in business, arming against the Chinese threat.  With Vice President Pence calling for a new Cold War against China, if not Russia, the grounds have been laid for an arms race even though the United States spends more on its defence budget than the combined budgets of China, Saudi Arabia, Russia, the United Kingdom, India, France, and Japan.  The US military justifies the new spending aimed at China because of its worries about having to fight on China’s or Russia’s home turf.

6. Slow Progress in North Korea

It’s in nobody’s interest for the talks to be stalled, but Kim Jung-un needs economic concessions before moving ahead.  Trump sees the peace talks as a major political success—he touted it during the midterm campaign.  Ending the talks would constitute a political failure just as he gears up for his re-election campaign late next year.   At the same time, he needs to show progress on disarming North Korea.  Kim—who is equally invested in the peace process—will do just enough to avoid Trump’s ire without full scale denuclearization.

7.  A Blow-up Coming in the Middle East

European efforts to salvage the JCPOA will fail as their financial mechanism to avoid US sanctions won’t persuade any major European firms to risk Washington’s ire by doing business with Iran.  Hardliners will push for Tehran to rescind its adhesion, setting in motion a possible confrontation with Saudi Arabia, Israel and US.  2019 probably won’t be the year in which the match is lit but it will lay the groundwork.  An aggressive MBS looks set to survive the Khashoggi scandal unless the tapes go public.  Any perceived Iranian provocation, particularly a restarting of its nuclear weapons programs, could rally voters to Trump’s side as the re-election campaign heats up.  Europe, Russia and China would need to unite and work closely for the crisis to be defused.  Any hot war between Tehran and Israel or Saudi Arabia won’t be containable, potentially inundating Turkey and Europe with migrants and endangering energy supplies.

8.  Imploding China

China could be the biggest medium-term bombshell with its trifecta of mounting debt, slowing economy and growing political repression.  There are signs of increasing discomfort by some members of the elite that President Xi is putting China out on a limb.  It’s not just Trump that believes China has kept its promises to open its markets.  Europe and Japan share similar resentments but are leery of associating themselves with Trump’s bombast.   Certainly, Xi miscalculated that China could become the leader overnight in new technologies such as AI without continuing help from the West.

A hard landing would have broader implications for the whole developing world given China’s central role in their continued rise.  A global middle class that has been counting on growing prosperity could be severely disappointed with widespread political instability the result.

9. Climate Change: The Risks of Inaction

By 2035, the point of no return could be crossed — after which it will be extremely unlikely we can stop Earth’s temperature from rising by 2 degrees Celsius (3.6 degrees Fahrenheit) and kicking off a dangerous medley of global disasters.^[1]  To avoid the point of no return, the world needs to boost renewables by 2% per year—an enormous task.  The biggest challenge will be incentivizing the developing world to switch from coal to cleaner fuels without undermining their economic development.    In this ever-increasing nationalist world, the idea of the West helping on a scale not seen since the Marshall Plan appears unrealistic.  Only a series of catastrophic climate-related events would motivate such an investment.  Although extreme weather and climate event have become more common and scientists now believe are increasingly likely earlier in the cycle, a more plausible trajectory will resemble a slow boiling frog, not waking up until it is too late.

Mat Burrows

November 2018

Footnotes

^[1] https://science.howstuffworks.com/environmental/conservation/issues/point-no-return-for-climate-action-is-2035.htm.