“How Can We Fix NATO Spending If Nobody Understands What Drives Global Economics?”

By Michael Every of Rabobank

1 Corinthians 13:11

“When I was an economist, I spoke as an economist, I understood as an economist, I thought as an economist: but when I became a man, I put away childish things.” – 1 Corinthians 13:11

Yesterday was quiet in markets because of the US Presidents Day holiday. But it wasn’t quiet in the real world, where the Houthis sank a UK-owned bulk carrier, underlining Congressman Gallagher’s complaint that US military sealift (in)capacity is a “screaming national security liability.” Which it is, even if most economists don’t know what sealift is: even so, it’s time for them to start doing wider reading, and thinking, before they too get sunk.

In that line, this time last week I was in Palm Beach for the ZeroHedge debate ‘The Fate of the US Dollar’ asking if the Buck could retain its global reserve currency status by 2030. Notably, the discussion didn’t center just on economics, but on political economy and the military. On one side, @JamesGRickards backed a BRICS+ currency linked to gold: after I retorted that ‘Eastern Powers in Goldmember’ is a parody, the Russian Foreign Minister agreed there will be no such thing. @BobMurphyEcon of the Mises Institute believed US public dissatisfaction with fiscal deficits and inflation could slowly shift holdings away from dollar financial assets. However, with the US top 1% dominating said holdings, it would mean the elite bailing on their own country and power (for where?) which seems a dramatic shift.

Countering, @SantiagoAuFund argued the global Eurodollar network and US military are too big if push comes to shove. I concurred, and added that: (i) if you can’t say what replaces the dollar, logic says it’s unlikely to do so; and, (ii) as long as the Fed keeps policy tight and US policy is more realpolitik than surrealpolitik, then the dollar stays top dog; or, as I also put it, “my dad is bigger than your dad.”

Former Fed voter Dudley is out today saying policy might be too loose, not tight, while Larry Summers is talking about the risks of the next move being a hike. That’s as the Thai PM pressures the Bank of Thailand for an emergency out-of-cycle rate cut, and China just slashed its 5-year LPR rate from 4.20% to 3.95% to little market impact. So, King Dollar still has the crown on its head.

Further underlining political economy matters most now, the European Commission President Von der Leyen just floated using the EU budget to subsidise defense production as well as guaranteeing it will be bought long term. The weekend’s Munich Security Conference was also abuzz with once-and-possibly-future President Trump’s threat to force NATO allies to spend more defence or see the US focus on itself. Presumed incoming NATO leader, former Dutch PM Rutte says Europe “should stop moaning and whining and nagging about Trump,” and focus on being able to defend itself – which has a long way to go.

Germany may now increase defence spending to a US-level 3.5% of GDP. Yet that means the EUR100bn special defence fund announced after Russia invaded Ukraine would be swallowed in a single year, and it would need to be repeated every year, plus an increase equal to nominal GDP growth, in order to *stay* at 3.5%.

That’s a *big* shift in fiscal policy that opens constitutional questions. So what kind of pan-European institutional would need to be put in place to achieve it? Relatedly, this morning Bloomberg is also talking about EU automakers also uniting into an “Airbus for cars” to try to resist competition from China. That would shake up the global economy and markets too.    

The need to act urgently is clear. Bloomberg notes today that ‘German Direct Investment in China Rose to Record in 2023’ at $6bn, even as total FDI into China collapsed to $33bn vs. around $350bn in 2021. Yet German FDI into the US soared to almost three times the China level for the first time, sending a message about deindustrialisation, with flows East and West instead.

However, how will defense spending and industrial policy be paid for? With high rates, things get very expensive, very fast. Yet low rates will see no private capital flow to military-industrial sectors, or even adjacent ones, or even domestically. Moreover, early/deep rate cuts may trigger higher inflation. (Look at US payrolls, initial claims, CPI, PPI, the ISM services prices paid, and loose fiscal policy. Even talk of cuts is generating dot-com insanity in some US stocks, and the record net short in speculative positions in grains can easily flip back to longs, pushing up food prices.)

So, cut welfare to pay for military spending? Spending on affordable bombs, not affordable homes, will only pour fuel on the flames of Western populism; the political-economy logic says we may need higher welfare AND military spending to justify the latter. Are we going to tax more to pay for it? Whom? The elite who could undermine US global reserve status, flighty businesses, or ordinary people who need fiscal help? Or are we going to monetize [ZH spoiler: we are]? One sees where the Austrian view of the fallibility of fiat flows from.

Regular readers will know I suspect a shift to higher rates AND ‘acronyms’ to ensure key sectors borrow at low rates to boost the supply and demand side in tandem; and, unspoken, that may require capital controls, hypothecated budgets, and tariffs as part of a national security economy where markets are free to do what the West wants, strategically – as China does.

That is already happening in part: and yesterday the US warned China not to dump its excess output on world markets. China ‘doing a Japan’ always threatened to accelerate the retreat from global free trade into open mercantilism. And here we are, even if many economists think what we are seeing means first order ‘deflation’ rather than second order ‘decoupling’.

But don’t bank on cheap Chinese goods keeping CPI in check; bank on efforts to keep FDI into China in check. The Bloomberg story on German FDI into China also quotes the Rhodium Group saying, “…a gap is emerging between the financial interests of some German corporations, on the one hand, and the interests of their Germany-based staff and the broader German economy, on the other.” A recent Daily referred to an MIT study (‘Wars Without Gun Smoke’) of exactly this historical pattern of behaviour in firms in rising vs. declining powers. Today it’s likely to mean politics injecting itself more into economics: and, coincidentally(?), we again see Germany’s BASF and VW are under pressure to cut their operations in China’s Xinjiang.

Real life is happening outside of economics, which doesn’t see it because of academic specialization, inertia, useful idiocy, and vested interests – but that’s not unique to it.

Indeed, as maritime expert @johnkonrad complains on X:

“Is there a national security finance conference or group I can attend? because miltweet is driving me nuts… Almost every military expert and natsec think tank on this app has mentioned GDP recently but only a few truly understand what GDP is or why it’s used (vs other metrics) for NATO spending. A tiny proportion of those truly understand fiscal and monetary policy. We cannot fix our military problems without understanding the underpinnings of fiscal and monetary policy… is it safe to assume the natsec community is financially illiterate? How can we fix NATO spending if our military think tanks don’t understand the underpinnings of global economics?”

NatSec ignorance of the economy and markets is as deep as economist and market ignorance of NatSec. In NatSec, if you say “GDP”, you’re ‘knowledgeable’; in economics/markets, if you say “geopolitics”, you’re ‘knowledgeable’. But it’s time to put away childish things, learn both, and look to 1 Corinthians 13:12: “For now we see only a reflection as in a mirror; then we shall see face to face. Now I know in part; then I shall know fully, even as I am fully known.”