Why everyone called Brexit wrong: Analysts have become too close to the elites they’re meant to analyse

I have long held heretical views about political risk analysis, which cluster around what I call the ‘plumber’s test’. However bejeweled or slick at marketing a political risk firm may be, what matters in the end is that they are analytically correct.

Just as I don’t invite back my local plumber if he fails to fix the pipes, nor should businesses put up with political risk firms who missed the war in Iraq’s predictable outcome, failed to see the coming of the Lehman crisis, or (more recently) failed to predict the Brexit vote. What holds for my plumber ought to hold for what I do for a living as well.

And yet, astoundingly, for all the million-dollar research departments in the City, and of all the major political risk firms out there, mine is the only one I know of to correctly call the Brexit vote. As far back as my prediction column for City AM in January 2016, we said Brexit would happen, to the general amusement of the commentariat and my competitors. Yet it is not an accident when the pipes are correctly fixed.

The main problem with Brexit political risk analysis revolved around the Pauline Kael fallacy. The legendary cinema critic of the leftish New York Times supposedly went wandering around, following Richard Nixon’s landslide 49 state victory in 1972, wondering how it was possible the incumbent won when everyone she knew voted for the hapless Democrat George McGovern.

There we have it in a nutshell. Top political risk analysts are always part of the elite they are supposed to assess. They all go the same cocktail parties, read the same books, inter-marry and share the same ‘right thinking’ views, all without wondering over-much about the wider world outside the cocoon of conferences at nice hotels. Intellectually trapped within an elite they are supposed to objectively analyse, political risk analysts have not covered themselves in glory recently.

Instead, both analysts and their clients have been shocked over and over again, a singular illustration of their lack of understanding of our changing world. They were gob-smacked by the recent Columbian vote against the Farc peace deal, just as they lapsed into incredulous, petulant rage over Brexit.

Like the mad, perpetually oblivious Roman Emperor Nero fiddling while Rome burned, gormless analysts seem somehow still unaware that–following on from the disastrous Iraq war and the equally calamitous Lehman crisis–most average humans simply don’t trust western elites anymore.

This is a tragedy on many levels. For after 500 plus years, the new world we are living in will not be exclusively dominated by a western ordering power. Following on from the Dutch, British, and American eras of hegemony, we are now entering a time when a rising Asia increasingly matters and where the West no longer calls all the shots. This means that the study of international relations is now truly global, and not just about what happens in Europe or North America. Political risk analysts that keep up with this sea change will do their clients a world of good.

Likewise, we are moving from the bipolar checkers game of US-Soviet great power competition to the far more complicated chess match of an era of many powers, where multiple interactions must be assessed. Standard international relations theory holds that such a complicated world is more dangerous, as there are simply more chances for great power miscalculation, and thus great power war.

On the other hand, there are more commercial opportunities in such a complicated place, if only political risk analysis can guide businesses to see the myriad glittering opportunities on the global chessboard. This world in transition means that there has never been a better or more lucrative time for political risk analysts to get their act together.

Published in City AM Money Magazine, October 2016

Saudi Arabia’s gormless cheerleaders have failed to spot the looming crisis

“Some people without brains do an awful lot of talking.”

–The Wizard of Oz

Conventional political risk wisdom is falsely sanguine about yet another looming crisis. The House of Saud, bullish proponents blithely declaim without giving the matter too much thought beyond simplistic headlines, has proven surprisingly supple and enduring. Yet in reality, Saudi Arabia is so much less than meets the eye.

Investors would seem to follow the commentariat lemmings over the analytical cliff. Just a week ago, Riyadh managed a successful bond offering of $17.5 billion, a record issue for an emerging market country. With its ambitious Vision 2030 plan for a diversified economy, a new dynamic de facto ruler in King Salman’s favoured son, Deputy Crown Prince Mohammed bin Salman, and even OPEC showing signs of life, Saudi Arabia is currently a ‘buy’ in terms of conventional political risk analysis.

Continuing their almost unbroken record for getting everything of significance wrong lately (Iraq, Lehman, Brexit, Columbia), look for the global chattering classes to be off base about this as well. For once we look beneath the analytical hood in terms of the economic and political fundamentals, in every case Saudi Arabia is in worse shape than recent headlines lead us to believe.

Riyadh’s disastrous effort to drive shale from the global energy market has boomeranged, inflicting maximum damage on its own one-crop economy (90% of government revenue comes from oil). The Saudi deficit has exploded from an average of around three percent to a gargantuan 16% in 2015, hardly a symptom of health.

While still not in the danger zone, Saudi reserves have plummeted from $740 billion as recently as mid-2014 to around $550 billion in October 2016. Even a government as flush as the House of Saud can’t continue burning through its abundant reserves at the present pace forever.

Nor are the political fundamentals of the regime anywhere near as secure as they look. Prince Mohammed has no obvious credentials to be my intern, let alone the de facto ruler of one of the Great Powers of the Middle East. He is only in that position for the precarious reason that he is the favoured son of the aging, ailing present king.

Prince Mohammed has overseen the disastrous war with Yemen. He has put himself in charge of Vision 2030, the most recent plan to economically modernise the country (store rooms are littered with previous failed attempts to do so). He is running the state-controlled oil industry. A man of prodigious genius—say Alexander Hamilton—could not manage to stay on top of all these demanding positions. A man with absolutely no background in running anything is going to be in for a rough ride.

Even barring these policy realities, Prince Mohammed’s position is far from secure. Given the challenges the opacity of Saudi internal political decision-making present for analysts, my political risk firm had long believed the best way to study Saudi politics is to look at the ruling family’s decisions through the prism of Ottoman Empire harem politics. The jockeying for power between the many family factions is the best indicator of Saudi outputs. By this yardstick, Prince Mohammed would do well to perpetually look over his shoulder.

For Mohammed’s father, King Salman, has overturned ruling family precedent by leapfrogging his son over literally dozens of claimants for the throne, a shocking departure in a system that has traditionally prized stability, harmony between the family factions, and venerated age as prerequisite for ruling. Because of all this, there are a lot of people within the House of Saud who would not shed a tear should Prince Mohammed fail.

Also, given King Salman’s unsure health, and the Delphic silence of experienced, canny Crown Prince Mohammed bin Nayef, there is absolutely no guarantee that the Deputy Crown Prince will not be thrown out on his ear when his father—his sole credential for holding power—departs the scene.

Even the recent ‘success’ of Saudi-dominated OPEC is more mirage than reality. The September 28th agreement in Algiers to finally limit cartel production is underwhelming. Specific cuts from individual members have yet to be agreed on, which means the current agreement is no agreement at all. Even for this exercise in public relations, Saudi Oil Minister Khalid al-Falih had to exempt Iran, Libya, and Nigeria from participation, making the deal not worth the paper it is printed on.

So beneath the cheerleading, Saudi Arabia remains a one-crop economy in economic difficulties, with an untested and politically vulnerable Deputy Crown Prince temporarily at the helm, manifestly unable to resurrect a corpse-like OPEC. I think we can hold off on the champagne for now.

Published in City AM London, October 24, 2016

Europe’s hidden barriers to economic excellence

In a sense, every macroeconomic debate I have had about Europe’s endemic malaise over the past 17 years always comes down to this: Given the undoubted quality of the continent’s higher education system (of which I myself am a grateful product), how can one explain that Steve Jobs, Bill Gates, Henry Ford, Thomas Edison, and Alexander Graham Bell are all Americans? Why is it that the market disruptors that create wholly new industries from scratch invariably come from the US, rather than from the other side of the Atlantic Ocean? I have perfected a telling response to this puzzling reality: In America, our mad tinkerers toil alone in their garages, which could never happen in Europe, as the EU would declare it an unsafe workspace.

There is much truth in this throwaway line. The US practices a form of benign neglect towards the odd men who create new worlds; it does not support them, but neither does it stand in their way, which is all too often the case in Europe. But now that tariff rates across the world generally rest at very low levels, another terribly destructive form of protectionism—always the enemy of the truly innovative—has reared its head, killing off the very innovators necessary to economically re-make a continent in desperate need of such dynamism. Junk science and false scares are blurring objective reality, knobbling European businesses, just as they struggle to find their footing in the highly competitive post-Lehman Brothers world.

Recently, I read about such a case in the very old European field of horticulture, long a hobby of mine. European wines are still—despite all the very healthy competition that has sprung up from North America, Australia, and South America—considered to be world-class, even if their margin of dominance is dwindling. At this critical juncture a European firm (Diam) has managed to develop a cork that does away with the endemic problem of cork taint, the undesirable smells and tastes that can be found in a bottle of wine, usually detected only after opening. Though there are a number of causes for this, the primary one involves the stopper, or cork, that secures the wine in the first place.

To do away with this problem is in a sense the holy grail for the winemaking industry, as cork taint can affect the wine, regardless of its price and quality. It is not too much to say that to regularise the product inside the bottle would be the next big thing in the wine industry. Secure corking would allow for greater European wine exports—especially Italian—throughout the world, as the basic continental comparative advantage in this field could be fully taken advantage of.

But of course such a market disruption, though beneficial for both European innovators and global consumers in general, is inherently threatening to those left behind the curve; innovation always has its enemies. Which brings me to the recent January 2016 claims by wine expert Rolf Cordes in the German wine review Wein Plus that Diam’s supposed innovation is actually a mirage. Cordes states that based on a personal study he conducted, that wines using Diam’s closures have a ‘persistent dry aftertaste’ that he describes amounting to ‘atypical bitterness’. In essence, Cordes is saying that Diam’s corks contribute to the problem of cork taint, rather than solving it.

Interested, I scanned the piece eagerly for the study details. I must say that when I actually found them, I almost fell off my chair laughing. Cordes took seven to eight wines (red, white, and rose) pouring 1.5 litres of each into a pair of identical jars. Of each pair, one jar was secured with a Diam cork and one with another brand. He then let them sit for between two and 94 days, reopening them to see how the wines had fared. From this ‘study’ Cordes made his rather sweeping pronouncements.

But this is all nonsense of the highest order. In terms of methodology, Cordes forthrightly admits he dipped the whole cork in wine, which in the real world is simply not how cork comes into contact with wine stored in a bottle. Even more puzzling, the study was replicated by ten other researchers conducting trials. While in terms of sensory testing it is difficult to get sufficient sized samples, a group of ten is an awfully low number to base such an important finding on. Why didn’t Cordes simply partner with a reputable lab or wine institute or university to give his findings real scientific rigour? Serious wine people, including Diam, rely on independent laboratory tests, as they absolutely should in terms of product testing, given their greater accuracy.

Further, Cordes displays a wilful ignorance as to how wine itself works; some vintages become more expressive with time, some do not. How did he choose his time periods for the red, white, and rose wines, and how did they relate to this important fact? We simply do not know. In other words, you can drive a truck through the holes in these findings, which amount to little more than junk science, allowing Cordes to use faux scientific rigour to get the results he wanted in the first place.

But if junk science is laughable, it is also economically dangerous. Falsely raising concerns–disparaging or raising questions about the safety or efficacy of innovative products–can do both them and the European marketplace great harm. Most businesses are inherently conservative, tacitly accepting the ‘Where there is smoke there must be fire,’ adage, wrongheaded though that may be. In other words, by simply muddying the waters, junk science can easily derail the innovations the European economy so desperately craves, leading to the triumph of inferior products, and robbing the consumer—and in this case, the winemaker–of the right to decide for themselves.

Now is not the time for junk science–another (if hidden) form of protectionism–to hobble the weak European market. Rather, innovators like Diam must be supported if the continent is to regain its rightful economic place in the sun.

Published in Aspenia online (Italy), October 18, 2016