Political and economic risks rise as US mid-term elections near

This is the Labor Day weekend in the USA – the traditional start of the mid-term election campaign.  And just as in September 2016, the Real Clear Politics poll shows that most voters feel their country is going in the wrong direction.  The demographic influences that I highlighted then are also becoming ever-more important with time:

Demographics, as in 1960 and 1980, are therefore likely to be a critical influence in November’s election:

  • Median age in 1960 was just 30, and 29 in 1964. Young people are by nature optimistic about the future, believing anything can be achieved – and their support was critical for the Great Society project
  • Median age was still only 30 years in 1980. The Boomers were joining the Wealth Creator 25 – 54 generation in large numbers. They were keen to join the Reagan revolution and eliminate barriers
  • Today, however, median age is nearly 50% higher at 38 years, and the average Boomer is aged 61.. The candidates are not mirroring Kennedy/Johnson and Reagan/Bush in focusing on the need to remove barriers. Indeed, Trump’s signature policy is to build a wall”

2 years later, the median age is still increasing, and the average Boomer is aged 63.

But there is one major change from 2 years ago.  Then, President Obama had a positive approval rating at 50.7%.  But today, President Trump has a negative approval rate of 53.9%.

This has clear consequences for the likely outcome of the mid-terms, with the latest FiveThirtyEight poll suggesting the Democrats have a 3 in 4 chance of winning control of the House.  In turn, of course, this increases the risk of impeachment for Trump and makes it even more difficult for him to stop the Mueller investigation.  We therefore have to assume that Trump will do everything he can to reduce this risk over the next few weeks.

Americans are not alone in feeling that their country is heading in the wrong direction, as the latest survey (above) for IPSOS Mori confirms.  And they have been feeling this for a long time – as I noted back in November 2016:

  • China, Saudi Arabia, India, Argentina, Peru, Canada and Russia are the only countries to record a positive feeling
  • The other 18 are increasingly desperate for change

Today Malaysia, S Korea, Serbia and Chile have moved into the positive camp.  But Argentina, Peru and Russia have gone negative.  And if we narrow down to the world’s ‘Top 10’ economies:

  • 7 of them are negative – 53% of Italians, 59% of Americans, 63% of Japanese, 66% of Germans, 67% of British, 73% of French and 85% of Brazilians
  • Only 3 are positive – 91% of Chinese, 67% of Indians and 52% of Canadians

There is a clear message here, as the median ages of the ‘Unhappy 7’ are also continuing to rise:

  • Median Japanese age is 47.3 years; Italy is 45.5; Germany is 43.8; France is 41.4, Britain is 40.5; US is 38.1, (Brazil is unhappy because of economic/political chaos, and is the exception that proves the rule at 32 years)
  • By contrast, China’s media age is 37.4 years, India is 27.9 (Canada is the exception at 42.2 years)

The key issue is summarised in the 3rd slide from a BBC poll, which shows that 3 out of 4 people in the world believe their country has become divided.  More than half believe it is more divided than 10 years ago.

There is also a clear correlation with the demographic data:

  • 35% of Japanese, 67% of Italians, 66% of Germans, 54% of French, 65% of British, 57% of Americans and 46% of Brazilians see their country as more divided than 10 years ago
  • Only 10% of Chinese, 13% of Indians and 35% of Canadians feel this way

POLITICIANS ARE INCREASINGLY FOCUSED ON ‘DIVIDE AND RULE’
One might have expected that politicians would be working to remove these barriers.  But the trend since 2016 has been in the opposite direction.  Older people have historically always been less optimistic about the future than the young.  And the Populists from both the left and right have been ruthless in exploiting this fact.

This trend has major implications for companies and investors. As long-standing readers will remember, very few people agreed with my suggestion in September 2015 that Trump could win the US Presidency and that political risk was moving up the agenda.  As one normally friendly commentator wrote:

“Hodges’ predictions are relevant to companies, he says, because of the likelihood of political change leading to political risk:

  • The economic success of the BabyBoomer-led SuperCycle meant that politics as such took a back seat. People no longer needed to argue over “who got what” as there seemed to be plenty for everyone. But today, those happy days are receding into history – hence the growing arguments over inequality and relative income levels
  • Companies and investors have had little experience of how such debates can impact them in recent decades. They now need to move quickly up the learning curve. Political risk is becoming a major issue, as it was before the 1990s

“Of course a prediction skeptic like me would say this, but I have a very, very, very difficult time imagining that populist movements could have significant traction in the U.S. Congress in passing legislation that would seriously affect companies and investors.” (my emphasis)

Yet 3 years later, this has now happened on a major scale – impacting a growing range of industries and countries.

As the mid-term campaigning moves into its final weeks, we must therefore assume that Trump will focus on further consolidating his base vote.  Further tariffs on China, and the completion of the pull-out from the Iran nuclear deal are almost certain as a result.  Canada is being threatened in the NAFTA talks, and it would be no surprise if he increases the economic pressure against the US’s other key allies in the G7 countries, given the major row at June’s G7 Summit.

Anyone who still hope that Trump might be bluffing, and that the world will soon return to “business as usual”, is likely to have an unpleasant shock in the weeks ahead.

 

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US PE exports on front line as Trump changes trade policies

It is almost a year since Donald Trump became President.  And whilst he has not followed through on many of his promises, he has indeed introduced the major policy changes that I began to discuss in September 2015, when I first suggested he could win the election and that the Republicans could control Congress:

“In the USA, the establishment candidacies of Hillary Clinton for the Democrats and Jeb Bush for the Republicans are being upstaged by the two populist candidates – Bernie Sanders and Donald Trump….Companies and investors have had little experience of how such debates can impact them in recent decades. They now need to move quickly up the learning curve. Political risk is becoming a major issue, as it was before the 1990s.

Many people have therefore had to go up a steep learning curve over the past year, given that their starting point was essentially disbelief, as one commentator noted when my analysis first appeared:

“I have a very, very, very difficult time imagining that populist movements could have significant traction in the U.S. Congress in passing legislation that would seriously affect companies and investors.

Yet this, of course, is exactly what has happened.

It is true that many of the promises in candidate Trump’s Contract with America have been ignored:

  • Of his 174 promises, 13 have been achieved, 18 are in process, 37 have been broken, 3 have been partially achieved and 103 have not started
  • His top priority of a Constitutional amendment on term limits for members of Congress has not moved forward

Yet on areas that impact companies and investors, such as trade and corporate tax, the President has moved forward:

  • On trade, he has not (yet?) labelled China a currency manipulator or moved forward to fix water and environmental infrastructure
  • But he has announced the renegotiation of NAFTA, the withdrawal from the Trans-Pacific Partnership, his intention to withdraw from the UN Climate Change programme and lifted restrictions on fossil fuel production

These are complete game-changers in terms of America’s position in the world and its trading relationships.

Over the decades following World War 2, Republican and Democrat Presidents alike saw trade as the key to avoiding further wars by building global prosperity.  Presidents Reagan, Bush and Clinton all actively supported the growth of global trade and the creation of the World Trade Organisation (WTO).

The US also led the world in environmental protection following publication of Rachel Carson’s ‘Silent Spring‘ in 1962, with its attack on the over-use of pesticides.

Clearly, today, these priorities no longer matter to President Trump.  And already, US companies are starting to lose out as politics, rather than economics, once again begins to dominate global trade.  We are returning to the trading models that operated before WTO:

  • Until the 1990s, trade largely took place within trading blocs rather than globally – in Europe, for example, the West was organised in the Common Market and the East operated within the Soviet Union
  • It is therefore very significant that one of the President’s first attacks has been on the WTO, where he has disrupted its work by blocking the appointment of new judges

Trump’s policy is instead based on the idea of bilateral trade agreements with individual countries, with the US dominating the relationship.  Understandably, many countries dislike this prospect and are instead preferring to work with China’s Belt & Road Initiative (BRI, formerly known as One Belt, One Road).

US POLYETHYLENE PRODUCERS WILL BE A CASE STUDY FOR THE IMPACT OF THE NEW POLICIES
US polyethylene (PE) producers are likely to provide a case study of the problems created by the new policies.

They are now bringing online around 6 million tonnes of new shale gas-based production.  It had been assumed a large part of this volume could be exported to China.  But the chart above suggests this now looks unlikely:

  • China’s PE market has indeed seen major growth since 2015, up 18% on a January – November basis.  Part of this is one-off demand growth, as China moved to ban imports of scrap product in 2017.  Its own production has also grown in line with total demand at 17%
  • But at the same time, its net imports rose by 1.8 million tonnes, 19%, with the main surge in 2017.  This was a perfect opportunity for US producers to increase their exports as their new capacity began to come online
  • Yet, actual US exports only rose 194kt – within NAFTA, Mexico actually outperformed with its exports up 197kt
  • The big winner was the Middle East, a key part of the BRI, which saw its volume jump 29% by 1.36 million tonnes

Sadly, it seems likely that 2018 will see further development of such trading blocs:

  • The President’s comments last week, when he reportedly called Africa and Haiti “shitholes” will clearly make it more difficult to build long-term relationships based on trust with these countries
  • They also caused anguish in traditionally pro-American countries such as the UK – adding to concerns that he has lost his early interest in the promised post-Brexit “very big and exciting” trade deal.

US companies were already facing an uphill task in selling all their new shale gas-based PE output.  The President’s new trade policies will make this task even more difficult, given that most of it will have to be exported.

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Brexit disaster looms as UK government power struggle erupts

UK voters were never very bothered about membership of the European Union (EU) before the Brexit vote last year.  Opinion polls instead showed they shared the general feeling of voters everywhere – that their country was heading in the wrong direction, and it was time for a change.  Now, last week’s Conservative Party conference showed that the government itself, and the prime minister, have also lost all sense of direction.

The problem is that nobody has any idea of a what a post-Brexit world would look like for the UK.  The Leave campaigners famously told the voters it would be a land where the UK would no longer “give” £350m/week ($455m) to Brussels, and could instead spend this money on improving health care and other worthy objectives.  This, of course, was a lie, as the head of the National Statistics Agency has since confirmed.  But then-premier Cameron failed to call out the lie at the time – fearing it would split his Conservative Party if he did.

15 months later, this lie has again come centre stage as the Foreign Secretary, Boris Johnson, revived it before the Conference as part of his bid to replace premier May:

“Once we have settled our accounts, we will take back control of roughly £350 million per week.  It would be a fine thing, as many of us have pointed out, if a lot of that money went on the NHS.”

As a result, the splits in the Conservative Party are out in the open, with its former chairman now calling for a leadership election and claiming at least 30 law-makers already support the move.  Bookmakers now expect May to leave office this year (offering odds of just evens), and suggest the UK will have a new election next year (odds of 2/1), despite the fact that Parliament has nearly 5 years to run.

May’s problem is two-fold:

 As the photo shows, she was humiliated in her main speech to the Conference by a prankster handing her a P45 form (the UK’s legal dismissal notice), and claiming Johnson had asked him to do it
 Her previous set-piece speech in Florence on negotiations with Brussels over the UK’s exit arrangements had also rebounded, as it made clear the Cabinet was divided on the terms that should be negotiated

Voters don’t like being lied to, and they don’t like governments that are unable to govern because of internal splits – particularly when the splits are over such a critical issue as the UK’s economic future.  Unsurprisingly, therefore, the opposition Labour party are now favorites to win the next election, and their leader, Jeremy Corbyn, is favourite to become the next prime minister.  This, of course, would confirm my suggestion 2 years ago:

“My local MP, Jeremy Corbyn, won the UK Labour Party leadership election on Saturday with a 60% majority. An anti-NATO socialist, he has represented the constituency for 32 years, and has never held even a junior ministerial post. Now, he could possibly become the UK’s next Prime Minister.

“His path to power depends on two developments taking place, neither of which are impossible to imagine. First, he needs to win back the 40 seats that Labour lost to the Scottish Nationalists in May. And then he has to hope the ruling Conservative Party tears itself apart during the up-coming Europe Referendum.”

Unfortunately, Corbyn would be unlikely to resolve the mess over Brexit.  In the past, before becoming leader, he took the Trotskyist view that the EU is a capitalist club, set up to defraud the workers.  He has since refused to confirm or deny his views on the subject, but he did take very little part in the Referendum campaign last year.  Had he been more active in arguing the official Labour Party position of Remain, it is unlikely that Leave would have won.

Today, he is far more concerned over the likely result of a Labour Party win on financial markets, with his shadow Finance Minister admitting recently they were “war-gaming” in advance of an expected currency crisis.  UK interest rates are already rising, as foreign buyers wonder whether they should continue to hold their current 28% share of the UK government bond market.  Clearly, it is highly likely that a Labour government would need to return to capital controls after a 40-year break, to protect their finances.

A VERY HARD BREXIT IS BECOMING ALMOST CERTAIN
The confusion and growing chaos in the political world means that the detail of Brexit negotiations has taken a back seat.  The UK has still to make detailed proposals on the 3 critical issues that need to be settled before any trade talks can begin – rights of EU/UK citizens post-Brexit; status of the N Ireland/Ireland border; UK debts to Brussels for previously agreed spending.  And most European governments are now far more focused on domestic concerns:

  As I warned a year ago, the Populist Alternative für Deutschland did indeed “gain enough seats to make a continuation of the current “Grand Coalition” between the CDU/CSU/SDP impossible” in Germany
  Spain has to somehow resolve the Catalan crisis, following last week’s violence over the independence referendum
  Italy has autonomy referenda taking place in the wealthy Lombardy and Venice regions in 2 weeks, and then faces a difficult national election where the populist 5 Star movement leads most opinion polls. The scope for political chaos is clear, as the wealthy Northern regions want to reduce their tax payments to the south – whilst southern-based 5 Star want more money to go in their direction

President Trump has also undermined the Brexit position.  He initially promised a “very big and exciting” US-UK trade deal post Brexit.  But since then the US has supported a protectionist move by Boeing to effectively shut-down the vital Bombardier aircraft factory in Belfast, N Ireland, despite May’s personal appeals to him. And last week, it joined Australia, New Zealand, Argentina and Brazil in objecting to the EU-UK agreement on agricultural quotas post-Brexit.

I have taken part in trade talks and have also negotiated major contracts around the world.  So I know from experience the UK could never have achieved new deals within the 2 years promised by leading Brexiteers.

Today, it is also increasingly clear that May’s government doesn’t have the votes in Parliament to agree any financial deal that would be acceptable in Brussels.  So whilst large parts of UK industry still assume Brexit will mean “business as usual”, European companies are being more realistic.    In a most unusual move, the head of the Federation of German Industries spelt out the likely end result last week:

“The British government is lacking a clear concept despite talking a lot. German companies with a presence in Britain and Northern Ireland must now make provisions for the serious case of a very hard exit. Anything else would be naive…The unbundling of one of Germany’s closest allies is unavoidably connected with high economic losses. A disorderly exit by the British from the EU without any follow up controls would bring with it considerable upheaval for all participants. (German companies feel) not only that the sword of Damocles of insecurity is hovering over them, but even more so that they are exposed to the danger of massive devaluation.”

UK, European and global companies are already drawing up their budgets for 2018 – 2020. They cannot wait until Brexit day on 29 March 2019 before making their plans. And so, as it becomes increasingly obvious that the UK-EU talks are headed for stalemate, and that ideas of a lengthy transition period are simply a dream, they will make their own plans on the assumption that the UK will head over the Brexit cliff in 18 months time.

Nobody knows what will happen next.  But prudent companies, investors and individuals have to face the fact that Brexit, as I warned after the vote, is likely to be “a disaster for the UK, Europe and the world“.

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Global supply chains at risk as trade war threat rises

Dreamliner Feb17

May God bless the USA and God bless Boeing” was President Trump’s sign-off in his speech on Friday at Boeing’s South Carolina factory.  Earlier he had told the workforce building the 787 Dreamliner:

“This is our mantra: Buy American and hire America. We want products made in America, made by American hands. Our goal as a nation must be to rely less on imports and more on products made here in the USA. We’re going to fight for every last American job.

Clearly the Dreamliner is a great success, with over 500 aircraft already delivered to more than 60 major airlines since its 2011 launch. But the factory assembling the Dreamliner relies on parts from all around the world.  As Business Insider describes, “The Dreamliner is like the United Nations of planes:

□  Its wings and batteries come from Japan. Its wing tips come from South Korea.
□  India is the source of its floor beams.  The front fuselage is made in the USA and Japan.
□  The center fuselage and horizontal stabilizers are from Italy.
□  Landing gear and doors? France.  Cargo access doors are built in Sweden.
□  The wing/body fairings, which cover gaps on the body, are from Canada.
□  The movable trailing edge of the wings are from Canada, except when they’re from the US or Australia.
□  Thrust reversers come from Mexico.
□  Its engines come from either General Electric in the US or Rolls-Royce in the UK”

Over the next 8 years, the President clearly has an opportunity to replace many of these imports with local parts.  But he is unlikely to be able to do this without impacting Boeing’s business model, which is based on accessing the world’s best brains and factories to produce the best possible aircraft at the lowest possible cost.

This model also creates a “win-win” for countries when buying the Dreamliner, as they are able to share in the value being created.  If Boeing changes its business model to a “win-lose” model – based on increasing US content at the expense of foreign suppliers -then its sales will inevitably suffer.  Trade wars will replace today’s global supply chains.

Nissan Jan17

It is a similar story in Europe as the UK prepares to exit the European Union (EU).  Nissan’s auto factory in Sunderland is the UK’s largest, exporting 55% of its output to the EU.  And it currently operates on the same global principles as Boeing, as the Wall Street Journal describes:

□  Bridgestone, the Japanese tire maker, supplies the Qashqai with tires made in Poland and Spain. France’s Faurecia provides seats made in Portugal, Poland and France, as well as emissions-control systems made in the UK
□  Italy’s Sogefi supplies springs made in Britain and Spain, and air-intake systems from a UK plant. Denso, a Japanese supplier, provides compressors made in Germany and a crank sensor produced in Japan
□  Parts also can travel back and forth between countries before being bolted to the inside of a car. A spring, for example, might be produced in Britain, sent to Germany to be inserted into a gear box and then shipped back to the U.K. as part of the finished component.”

Yet UK Premier May has promised that the UK will begin the process of leaving the European Single Market next month.  In exchange, the government has offered just 4 assurances to UK-based auto companies:

“To ensure more suppliers located in the UK; to commit Britain to research and development into electric and ultra-low emission vehicles; to support jobs and training; and to push for a deal with the EU that allowed automotive trade to continue ‘free and unencumbered’.”

In reality, of course, May has no control over whether auto suppliers choose to locate in the UK.  Nor can she guarantee that UK car exports will continue to have free access to the EU.  What therefore will happen to the UK’s critically important auto industry if she proves unable to deliver on her promises?

We already know that the EU plans to focus the Brexit negotiations for the rest of this year on finalising the UK’s exit bill (estimated at €60bn, $57bn) and the rights of expatriate citizens. This means the UK will have just a year to discuss longer-term trade deals before exiting the EU in March 2019. Almost inevitably, this means the UK will then be forced to use WTO terms for all its trade – with the EU and the rest of the world – until new deals can be finalised.

MOST MAJOR COMPANIES OPERATE WITHIN WITHIN GLOBAL SUPPLY CHAINS
It is also easy to forget that today’s global supply chains don’t just impact the aerospace and auto industries.  These in turn rely on components sourced from a vast range of suppliers – including plastics, chemicals, textiles, paints, electronics, metals and many others. As today’s trade agreements disappear, all of these supply chains will be at risk:

□  A company that currently supplies a customer in Asia, Europe or N America probably doesn’t know that its end-use is in a Dreamliner or Nissan car, or one of the other millions of products that depend on global supply chains
 They will only find out as as protectionism and trade wars spread, and their sales start to decline
□  Instead of today’s “win-win” relationships, they will find themselves forced to operate under World Trade Organisation rules, which are only designed to meet very basic needs

As the WSJ notes with regard to the UK auto industry:

“Tariffs stipulated by the World Trade Organization, used as benchmarks for countries with no trade pact, stand at 10% for cars and between 2.5% and 4.5% for components.”

History shows that nobody can control what happens next in any war, or trade war.  Usually, the “winner” decides they can make further gains, and the “loser” tries to regain what they have lost.  Today’s trade wars are following this pattern.  They are starting slowly and locally, but will soon spread globally as the list of losers starts to multiply.

 

Basic Skills, not protectionism, key to sustaining today’s High Income, Services-based economies

Sevices 2014

Suddenly, manufacturing and protectionism have become political issues across the Western world.  President Trump has already formed a Manufacturing Council with the aim of “reshoring jobs” from outside the USA, and is threatening to introduce import duties of up to 45%.

The problem, however, as the chart shows, is that this will not help the people who voted for him.  Manufacturing is not the key to future success for a High Income economy like the US.  Its real importance has always been as the mechanism for Low Income economies to become Middle Income:

  The US moved from being Low to Middle Income long ago and is now a High Income economy based on Services
  High Income economies are 74% based on Services – Industry is just 25% of GDP (World Bank 2014 data)
  By contrast, GDP in Middle Income economies is 35% based on Industry, with Services at just 56%
  GDP in Low Income countries is only 48% based on Services, Agriculture is well ahead of Industry at 31%

The real problem facing the US and other developed societies is two-fold:

One is that the the wealthy developed world has moved into the fourth stage of the Demographic Transition.  As the IMF noted 10 years ago:

“Industrial countries have largely completed what is called the “demographic transition”—the transition from a largely rural agrarian society with high fertility and mortality rates to a predominantly urban industrial society with low fertility and mortality rates”.

But this has never been explained to voters.  Western political leaders didn’t want to have difficult debates about the the key issue raised by collapsing fertility rates and increasing life expectancy – how do we retrain people in their 50s and 60s to ensure they continue to contribute to economic growth?   Instead, they preferred to hope that central bank stimulus could somehow replace the loss of babies.

Today, the voters’ patience is starting to wear out.  They see little evidence of growth returning to the earlier SuperCycle levels, when most of the population were in the Wealth Creation 25 – 54 generation.  And so they are looking for new leaders, who will do a better job of protecting their living standards.

Basic skills

This is where the second problem becomes critical.  Unfortunately, Western education systems have not provided every voter with the Basic Skills they need to work successfully in a Services-based economy, as the second chart (from the new UK government Industrial strategy) highlights:

  Sadly, 30% of US adults aged 16 – 65 lack basic numeracy and literacy skills to OECD Level 2 standard
  Other major economies – Germany, UK, Poland, France, Spain, Italy – are also above the OECD average of 22%

It is therefore no great surprise that large numbers of adults, who have not voted regularly in previous elections, are now becoming more active.  Populist policies have an obvious attraction for them, as they feel their country is heading in the wrong direction.

Computer skills Nov16

The third chart highlights an even more serious side of this issue, namely the very low levels of computer skills across the OECD.  These are critical for an increasing number of jobs, but the OECD reported last year that nearly three-quarters of adults have poor (or lower levels) of computer skills.  As they also noted:

There is a strong positive relationship between problem-solving proficiency (in technology-related areas) on the one hand and literacy, and numeracy proficiency on the other.

Education policy is not something that can be changed overnight.  It will take years, if not decades, to replace today’s failing systems and to provide adults with the Basic Skills they have been denied.

Protectionism, on the other hand, appears to offer almost immediate prospect of change.  Only later will it become apparent that its main role has been to turn back the clock on incomes and the economy.

“Business as usual” the least likely outcome for Europe

EU Feb17

Europe is heading in to the Great Unknown, as Monday’s post highlighted.  The UK, The Netherlands and France are not the only political uncertainties that we face.  Elections are also due in Italy and in Germany.

   Italian elections. After premier Renzi’s referendum defeat last year, it seems like that Italy will hold elections this year, probably in the next few months. A the moment, the most likely winner is former comedian Beppe Grillo.  As I have discussed before, his main policy is for a referendum to exit the euro, but stay in the EU.  But, of course, it is also possible that the current Gentiloni government might survive until the scheduled election date in 2018.

If Grillo wins, the entire European banking system is likely to go bankrupt, as well as the European Central Bank (ECB).  The reason is that leaving the euro, and returning to the lira, would inevitably lead to a major devaluation of at least 20%.  As the ECB is the main owner of  Italian government debt, thanks to its Quantitative Easing programme, it also would go bankrupt.  As Astellon Capital note, the critical legal issue is that the Bank of Italy is privately owned by the Italian banks – not state owned.  The ECB claims the government would still be responsible for the debt, but investors and other governments are unlikely to wait around for Italy’s slow-moving courts to reach a decision.

   German elections. In October we then have the German elections, where Angela Merkel is seeking a fourth term.  Her credibility has been badly damaged by her handling of the refugee crisis, although most polls suggest she is still the favourite.  Germany also has a growing challenge from an anti-EU party, the Alternative für Deutschland (AfD).  But her main opponent is the new pro-EU leader of the Social Democratic Party (SDP), Martin Schulz.

A win for Merkel would obviously be “business as usual”.  But if Schulz wins, he would bring a new dimension to the political debates over the future of the EU, as he was the President of the European Parliament until he resigned to seek the leadership of the SDP. Whereas Merkel saw herself as a “safe pair of hands”, Schulz is likely to be a more activist Chancellor, if elected. His reputation at the Parliament was of “someone who got things done”.  But his actual policy objectives are unclear at the moment.

COMPANIES AND INVESTORS NEED TO PREPARE FOR VERY DIFFERENT OUTCOMES
Voters have got tired of waiting for change to take place.  As I noted in November, 69% of Germans, 82% of Italians and 89% of French feel their country is going in the wrong direction.  So they are prepared to try different options, just to see what might happen.  In turn, this means that Europe, and the world, is entering a Great Unknown.  At least 4 quite different alternatives could therefore result from this year’s elections:

  Business as Usual.  Perhaps Rutte, Fillon and Merkel will win their elections, Gentiloni survive into 2018, and May get her Brexit deal.  But this seems just a 10% probability today
  A triumph for the Populists. Populist success could continue, with Wilders winning in The Netherlands, Le Pen in France and Grillo in Italy, whilst the AfD wins a strong position in Germany.  This is a 25% probability
  Smörgåsbord. Each country might go its own way, with Wilders winning in The Netherlands, Macron winnng in France, Gentiloni surviving into 2018 in Italy, and Merkel winning in Germany.  This is also a 25% probability today
  A New Broom.  Wilders wins in The Netherlands and Grillo in Italy, whilst Macron and Schulz win in France and Germany.  This is perhaps the most likely outcome, but has only a 40% probability

Each of these outcomes would have radically different implications for companies, investors and us as individuals. The Populist, Smörgåsbord and New Broom outcomes would also give very different outcomes for the Brexit process. It could easily become of only marginal importance for EU leaders, if “business as usual” options disappear.  In turn, this would make May’s position back in the UK, very difficult indeed.

Nor can one ignore the potential impact of events, such as a Greek default, or of further interventions by Presidents Trump and Putin.  Both would be happy to see the EU disappear. These widely differing alternatives highlight the dangers of continuing with a one-dimensional view of the world based on economics.  Political risk has returned, and is likely to continue rising up the agenda for a long time.

We are entering the Great Unknown in Europe over the next 9 months.  Everyone will have their own views of the probabilities.  But the crucial point is that every country in the world is likely to feel the impact, in some way, if “business as usual” fails to occur.  And it will then be too late, at the end of the year, to suddenly wake up to the implications for your business, and for you personally.