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Identity crisis

Accounting for China’s effects on global trade and resource allocation

Le petit problème Pettis du laissez faire

Last week one of my oldest friends sent me a YouTuber’s critique of Michael Pettis, a man described therein as “one of the most influential economists” you’ve never heard of. I reference Mr. Pettis all the time, so if you’re a long-time reader or follow me on X where I regularly retweet his insights, you probably have heard of him. If you haven’t, don’t worry, I’ll explain.

I’ve followed Mr. Pettis’s writings for two decades and interviewed him almost a decade ago. For most of that time he was familiar only to China watchers as one of the leading analysts of its economy. But lately, as his ideas have been used to justify trade restrictions on China, he has come under attack as an economic radical who threatens laissez-faire, free-market economics. Nothing could be further from the truth. Instead, Mr. Pettis explains how China manipulates other countries’ laissez-faire policies to undermine free trade and the efficient allocation of resources around the globe.

Why this matters

Michael Pettis’s thesis plays an important role in my framework for thinking about China’s impact on the world and, thus, the responses brewing to it in the US, Europe and elsewhere. Hence, it’s worth describing his ideas, the criticisms of them, why those are wrong, and where I diverge from Mr. Pettis. Unfortunately, because his thesis is based on two economic identities, I am going to have to define some terms and take you through some simple arithmetic to explain them. This piece also is a little longer than my usual Seriously, Marvin?! articles. I apologize in advance.

Boring national income accounting

An identity is a mathematical equation that is true by definition. Most of macroeconomics relates at some level to two identities that define what national income, or gross domestic product (GDP), is. Why two identities? Because you can define GDP in terms of where income comes from or where it goes.

Think first of how income is generated: someone must produce and sell something. The “expenditure approach” to measuring national income defines it as the sum of all sources of spending in an economy, since that expenditure ultimately accrues as household income either through wages paid to workers or profits paid to proprietors and shareholders. Hence, we can measure GDP as follows:

(1) Y = C + I + G + (X – M)

(Y) GDP = (C) household consumption

+ (I) investment in factories or houses

+ (G) government purchases

+ (X – M) exports – imports (or, net exports)

Note that imports, which are the products of another country, are subtracted from domestic expenditure because they don’t generate domestic income. This equation should be very familiar to anyone who has taken even an introductory course in economics. But you can also think about how households use their income (somewhat confusingly called the “income approach”):

(2) Y = C + S_h + T

(Y) GDP = (C) household consumption

+ (S_h) household savings

+ (T) taxes paid to government

I.e. income is used to consume, save or pay taxes. Here’s where we do a little math. Since both identities define national income, GDP, we can set them equal to each other and, with a bit of algebra, derive a new identity that defines international trade:11

(3) (X – M) = S_h + S_g – I, where S_g = (T – G), or government savings, the excess of tax receipts over government spending (usually negative)

or, since household (S_h) plus government savings (S_g) equals national savings

(X – M) = S – I

If you stop to think about it, this equation is surprisingly intuitive: if a country doesn’t produce enough construction materials and machines to build the factories or houses it wants – i.e. it wants to invest more than it can produce or save – it must import those materials.

But how does a net importer pay for imports beyond its exports (which provide necessary foreign currency)? It must “borrow” the money from a net exporter. That borrowing could be short-term trade finance loans, or it could be more permanent, i.e. the net exporter could buy assets from the importer, like the importer’s government bonds or shares in its companies. This provides the savings the net importer lacks to fulfill its desired investment. This leads to one more identity that will be useful. Just as we approached GDP from both the “expenditure” and “income” sides, we can do the same with the international trade identity in equation (3) with an identity defining how net exports are paid for:

(4) (X – M) net exports = (–KA) private financial asset purchases

+ (dR) change in FX reserves

That is, a net exporter can finance importers’ purchases of its net exports by buying assets from the importers, either by private companies and citizens, or as official foreign exchange intervention.

We are now armed with the mathematical identities to explain Mr. Pettis’s thesis. But there are two important points to remember about these identities. First, they are not theories, they are true by definition. Second, they must hold across all countries. Unless we start trading with Mars, one country’s net exports are someone else’s net imports.

Mr. Pettis’s simple idea

Mr. Pettis makes two remarkably simple but easily missed points based on these identities. First, if a country can control both its domestic savings and investment, by definition it can wholly determine its net exports since the difference in the former equals the latter. Second, if a country can control its net exports, it forces other countries’savings and investment to adjust to accommodate it because trade must sum to zero globally.

These insights form a powerful idea: if – and this is the big question, if – a country can manipulate its domestic savings and investment through industrial policies, then assuming other countries do nothing to counter it, i.e. pursue laissez-faire policies, the manipulating country can force adjustment of the rest of the world’s savings and investment. If the country in question is relatively small, it probably doesn’t have a large macro effect (though it might in specific industries where industrial policies are concentrated). But if it is a large country, like China, it can create major distortions in the global economy.

Manipulating savings and investment

As noted, Mr. Pettis’s insight hinges on a big, controversial “if.” How can a country, particularly a large one, control both savings and investment across millions of households and companies? Mr. Pettis identifies several ways in which Chinese policy intentionally suppresses consumption to boost national savings and directs both the level and allocation of fixed-asset investment within the country.

  • Wage repression: The household income share of GDP in China is remarkably low relative to other countries, in part due to wage suppression. Workers in China require local residency permits (the hukou system) that creates two tiers of wages: higher wages for local workers with valid work permits and lower wages for migrant workers from poorer provinces lacking local permits. By managing the flow of hukou – issuing permits and cracking down on migrant employment – Chinese provincial governments can suppress both tiers of wages by increasing the effective labor supply.
  • Financial repression: China’s financial system is closed by capital controls and highly regulated, reducing the investment opportunities of households and encouraging higher savings rates. Bank interest rates on deposits are regulated and held at artificially low levels to enable banks to direct lending to favored industries at below-market rates. Few other domestic savings opportunities exist: real estate (hence the now collapsing property bubble), domestic stocks, and unregulated “wealth management” products that are another form of directed bank lending. Foreign investment is constrained by capital controls.
  • Land seizure and reallocation: Local governments force rural owners to sell land to the government at low, state-determined prices, repressing rural households’ wealth. The acquired land is then used by local governments either to generate government revenue via land sales (at marked-up prices) to property developers, or to stimulate investment in targeted industries through land grants or below-market price sales to state-owned enterprises (SOEs).
  • Exchange rate undervaluation: Throughout its most rapid phase of development, China intervened heavily in currency markets to prevent the renminbi from appreciating. Brad Setser at the Council on Foreign Relations documents continued stealth interventions via state-owned banks that have accelerated recently.22 Comprehensive capital controls allow China to decouple its domestic monetary policy from its exchange rate interventions, preventing the liquidity they create from driving inflation. Without inflation raising both the domestic and international price of Chinese goods, FX intervention depresses the real value of the renminbi. This raises the cost of imports for consumers, suppressing consumption, and encouraging domestic investment in import substitutes.
  • Retained earnings of firms: The state-owned enterprises that dominate China’s economy, particularly in fixed asset investment and in strategically important industries, reinvest earnings at unusually high rates relative to other “private” Chinese companies, which reinvest earnings at unusually high rates relative to non-Chinese companies. This increases both national savings and investment and simultaneously denies households dividend income.

Criticality of capital controls

The critical ingredient is China’s comprehensive capital controls. Without the ability to trap households’ savings within China, the power to regulate interest and dividends paid to households, to direct savings from banks, or to dictate land distribution would be useless. But by creating a closed system, capital controls mean that Chinese policymakers largely can determine domestic savings and investment. It’s also important to remember that all firms in China, not just SOEs, are instruments of state policy: by law, every large company in China, public or private, must have an active Communist Party cadre that aligns its activities with state policies and priorities.33 Further, China augments its state-directed lending and investment with a massive subsidy program that the Center for Strategic and International Studies estimates at almost 2 percentage points of GDP per year.44

The manipulation that matters

While China’s currency manipulation is a major focus of the US Treasury – and supposedly the IMF if it did its job – Mr. Pettis’s framework makes clear it plays a small role in the overall strategy. Yes, relative prices matter for trade (and suppression of Chinese households’ consumption) but the ability to manage national savings and investment in the international trade identity, equation (3), forces both domestic and foreign prices to adjust. That’s the real manipulation. Indeed, if one combines the international trade and finance identities above it becomes clear that the biggest effect of FX intervention is to “macromanage” savings and investment, which, even with China’s capital controls, are difficult to micromanage from the bottom up:

(5) (–KA) private financial flows + (dR) FX intervention =

(S) national savings – (I) investment

By adjusting dR on the left side – or as Mr. Setser points out, increasingly –KAthrough state-owned banks’ foreign asset purchases – Chinese policymakers can fine tune net savings flows on the right side, and thus net exports.

Critique#1: Identities aren’t causal

The first major criticism of Mr. Pettis’s framework is that mathematical identities aren’t causal. This is true in a textbook or in trade between countries pursuing laissez-faire policies. Under those conditions, if a government restricted interest paid by banks or forced banks to lend to unproductive enterprises, savers would send their money abroad and banks would go bankrupt. But in China, capital controls trap domestic savings inside the country, leaving households with no other choice, and bad loans are segregated from banks’ balance sheets into government-funded “bad” asset managers that absorb the losses as fiscal expenditure.

Quite ironically, some of the same economists leveling this criticism at Mr. Pettis insist, because government savings is part of national savings, that equation (3) implies the US current account deficit is “caused” by the US fiscal deficit. Yet in an open economy, where domestic savings and investment are free to adjust in response to government dissaving, the fiscal deficit can and often does move differently to the trade balance because identities are notcausal in an open economy. China, however, is a closed economy, so policy does have the power to manipulate identities for causal effect.

Critique #2: China’s production is more efficient

The more common criticism of Mr. Pettis’s thesis is that China dominates manufacturing not due to industrial policies but because its manufacturers are “more efficient.” By “efficient,” those making the claim generally mean that Chinese carmakers like BYD sell sophisticated, market-leading cars at prices well below those of inferior German, Japanese or US cars. But that’s not evidence of efficiency if the cars are being sold at a loss. Even before it became front-page news that BYD and every other Chinese auto maker is struggling to pay their suppliers, it’s been clear for decades from earnings reports and the performance of Chinese stocks that Chinese companies fail to generate profits.55

China’s poor efficiency is even apparent in the aggregate data. As I discussed in Ain’t misapplyin’, China’s total factor productivity growth – i.e. its value added above its cost of labor and capital – has been negative for over a decade. Put another way, all the capital lavished on BYD by Chinese banks would have had a higher return in Germany, Japan, the US, or nearly anywhere else. It’s easy to make “cheap” sophisticated products if you have access to free, unlimited capital, but that’s not the same as efficient. That’s the point of Mr. Pettis’s thesis: by suppressing consumption to boost savings and then direct it to targeted industries, China has engineered its economy to create underpriced capital that allows its manufacturers to produce below the marginal costs of international competitors.

You got a lot of explaining to do, Mr. Critic!

If Mr. Pettis’s theory is wrong, his critics have a lot of big mysteries to explain. For starters, how has China, for over 30 years, sustained an investment share of GDP that no other country could maintain for more than a decade, and even then, usually ended in an economic crisis (e.g. Japan, Thailand, Korea; see Figure 1)? Why, over the same period and contrary to all economic theory, did China export a significant share of its savings each year to richer countries, peaking at 10% of national income during China’s fastest phase of development (Figure 2)? How did it maintain interest rates that were below almost any other emerging economy and even most advanced economies while it was investing at such high rates and still exporting a significant portion of national savings? And why did its stock market underperform over that period if it was such a productive place to invest?

The questions themselves make clear that China’s economy is not now and never has been a market economy. They also are nearly impossible to answer without making use of Mr. Pettis’s insights. China can maintain unprofitable rates of investment that would bankrupt any other nation because it represses its citizens’ consumption to create the savings needed to fund cheap, targeted bank loans to manufacturers and to pay for fiscal authorities to wipe away the losses that accrue from inevitable overinvestment. China’s size and ability to do this has a major impact on resource allocation in the rest of the world, effects that are now generating unprecedented shifts in economic policy elsewhere in response. This is why I regularly cite Mr. Pettis in my analyses of how China’s policy affects the rest of the world (see for instance, Incompatible drag).

Where I differ: motives

Mr. Pettis and I both agree that China’s overinvestment is intentional, not accidental, and on the mechanism used to achieve it. But we differ on the motivation for it. Perhaps because Mr. Pettis lives in China, where he is a professor of Finance at Peking University, he ascribes more benign motives for China’s distortion of global resource allocation. In his view, the original motive was – following Germany’s, Japan’s and Korea’s lead – accelerating development. But once the system became entrenched, it was hard for the special interests that benefitted from them, namely SOEs and the Chinese Communist Party members who run them, to give the system up.

While I accept that entrenched interests play a role, I think the evidence points to national security policy being both the original and continuing reason for China’s economic policies. Both the industries targeted – all critical industries for military development – and the broader effects of intentional overcapacity fit too nicely within the framework of Unrestricted Warfare, a book written in 1997 by two (then) People’s Liberation Army senior colonels on how to counter America’s superior technological and military might.66 Intentional overcapacity serves multiple purposes: it undermines strategic competitors’ industrial capacity, it creates monopoly powers that can be used offensively (e.g. refined rare earth), and it offers rapid technological progress by running many concurrent (costly and mostly failed) experiments. The last may not be economically efficient, but it is time efficient for a country that was in a hurry to catch up with the West.

Whether Michael Pettis is right about the motives of Chinese policymakers or I am doesn’t change the macroeconomic effects. They are real and are shaping the global economy. Denying the Pettis model leads both to bad policy responses and misinformed judgements on markets. But understanding the motivation, or how that motive is perceived in, for instance, Washington, makes a big difference in other country’s policy responses.

Comment

1

Technically, the equation is CA = S – I, where CA stands for the current account balance. The difference between the current account and trade balance is so-called factor payments: a country not only earns money abroad from its exports, it earns interest and dividends on its foreign assets; similarly, it not only pays foreigners for imports but interest and dividends on their assets in the country.

2

“The Case that China is Now Actively Resisting Pressure on the Yuan to Appreciate,” Brad Setser, Follow the Money Blog, Council on Foreign Relations, 16 June 2025.

3

“CCP branches out into private businesses,” Jerome Doyon, East Asia Forum, 11 August 2023; and “Political governance in China’s state-owned enterprises,” Xiankun Jin, Liping Xu, Yu Xin, & Ajay Adhikari, China Journal of Accounting Research, vol. 15, no. 2, June 2022.

4

“Red Ink: Estimating Chinese Industrial Policy Spending in Comparative Perspective,” Gerard DiPippo, Ilaria Mazzocco, Scott Kennedy, & Matthew P. Goodman, Center for Strategic & International Studies, 23 May 2022.

5

“China’s car industry runs on empty as supply chain bills go unpaid,” Gloria Li & Haosiang Ko, Financial Times, 13 June 2025.

6

There are several translations of the book to English, but an abridged version made available by the US Foreign Broadcast Information Service is available free online.

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Economic and market forecasts:

Economic & market forecasts
  • Sustained higher US rates, vulnerability of backend rates and term premia to steepening in H2 2023: Are we there yet?

  • No recession, continued strength of US economy throughout 2023: Solved: Drivers of the dollar cycle; Clash of the Themes; Are we there yet?; Opportunity knocks: Are you listening?; Götterdämmerung.

  • No backtracking or “pivot” by the Fed in 2023: Solved: Drivers of the dollar cycle; Clash of the Themes; Are we there yet?; Opportunity knocks: Are you listening?; Götterdämmerung.

  • No banking crisis or reversal by the Fed following the failures of Silicon Valley Bank: Did QE cause bank failures? Opportunity knocks: Are you listening?

  • No new “Plaza Accord” resulting from US dollar strength and Fed rate hikes in 2022: Plaza 2.0 bid, not offered.

  • No default by Nigeria before or in the aftermath of the 2023 national elections: Debt reality versus perceptions.

  • The continued fall in US real rates through the 2000s and early 2010s. Themes & framework: Mercantilism (with Chinese characteristics) and the associated $Bloc/Chinese co-prosperity sphere undermined the marginal product of capital in the US while simultaneously increasing non-US demand for US Treasuries.

  • Emerging market outperformance in the 2000s. Themes & framework: Mercantilism (with Chinese characteristics) drove both the development of the $Bloc/Chinese co-prosperity sphere and the commodity supercycle, while Apex neoliberalism supported institutional reforms that lowered EM risk premia, all of which encouraged foreign direct investment that raised productivity and led to rapid economic growth.

  • The end of emerging markets’ “original sin” and growth of EM local bond markets, a development supported by a G7 initiative that I led at the US Treasury. Themes & framework: The $Bloc/Chinese co-prosperity sphere provided a new stability in many EM exchange rates while institutional reforms undertaken by many as part of Apex neoliberalism lowered EM risk premia.

  • The Global Financial Crisis (albeit see admission of errors below). Themes & framework: Mercantilism (with Chinese characteristics) and $Bloc/Chinese co-prosperity sphere simultaneously increased incentives for debt finance in the US (as demand for “safe” USD bonds rose globally) while undermining US means of repayment as the US marginal product of capital in traded goods fell. Combined with poorly designed bank regulation that allowed banks to leverage themselves well beyond regulators’ intent (Apex neoliberalism), “complexity cascaded”.

  • The failure of QE to generate post-GFC inflation. Themes & framework: Believing is being: inflation expectations were stable to falling amid deleveraging and associated lethargic income growth, lowering real interest rates as nominal rates were pinned at the zero lower bound, and implying sustained weak money demand. Stuffing banks with more reserves changed none of those variables. As Keynes described seven decades earlier – in the absence of negative nominal rates – monetary policy at the zero lower bound is equivalent to “pushing on a string”.

  • The lack of effect of balance sheet runoff on interest rates. Themes & framework: Believing is being and portfolio theory rejected the then dominant “portfolio balance” theory of QE. QE was a credible commitment by central banks to keep rates on hold, suppressing expectations for future rates and thus the yield curve. This is why the “Taper Tantrum” had its largest effects on 3-5 year forward rates as expectations for rates hiked rose, while long-dated forward rates fell. Measures of long-dated term premia continued to fall as the Fed reduced its balance sheet.

  • Peak Chinese growth in 2011. Themes & framework: Mercantilism (with Chinese characteristics) led to unsustainable contributions of investment to GDP and a collapse in China’s marginal product of capital amid historically large debt to GDP, a phenomenon that peaked with China’s 50% surge in domestic credit in response to the GFC. Domestic funding of its debt trapped China within its own financial repression scheme, frustrating its efforts to unwind its $Bloc/Chinese co-prosperity sphere and internationalization the renminbi as a closed capital account is required to avoid savings flight and a collapse of the debt bubble. This self-funded debt bubble implies that losses from consequent overinvestment are “amortized” in the form of slower growth.

  • Emerging Market underperformance of the last decade (and likely future decade). Themes & framework: Institutional reform in EM peaked with US policy credibility before the GFC under Apex neoliberalism; China’s peak within Mercantilism (with Chinese characteristics) in 2011 and the associated end of the commodity supercycle ended the “pack” economic benefits of the $Bloc/Chinese co-prosperity sphere, while simultaneously the advent of Localization began to shift production back to advanced economies. Amid stagnating growth and backsliding reforms, EM FX and asset prices looked (and continue to look) overvalued and risk spreads remain too thin.

  • Falling USD reserve share in the 2000s and a rising share since peak China. Themes & framework: The massive reserve accumulation required to sustain undervalution of the $Bloc/Chinese co-prosperity sphere came to be seen as “sovereign wealth” that required diversification, rather than a liquidity store for crises, and led to a consequent fall in the USD share of reserves. Yet the greater financial openness and cross-border claims that accompanied the Apex neoliberalism necessarily implied a proportional increase in capital outflows in periods of risk aversion; i.e. historically large reserves were not as large as perceived in reality. As China and the $Bloc/Chinese co-prosperity sphere slowed after 2011, and Global entropy increased Uncertainty with attendant effects on risk aversion, emerging markets learned painfully in 2014 that reserves were neither excess nor sovereign wealth, but instead necessary liquidity, and that the USD’s safe haven properties were unparalleled.

  • Low and falling inflation throughout the 2010s. Themes & framework: Missingflation, the unexplained trend component of global inflation that had led to two decades of inflation overforecasting by economists, showed no signs of abating and seemed to be caused by a continued slide in inflation expectations (Believing is being) as central banks struggled with the zero lower bound. The end of the trend would require both for central banks to make more credible commitment to raise inflation in conjunction with a sustained positive inflation shock.

  • The (trend) bottoming of long-term US real rates, higher-than-expected peak in Fed funds rates and US equity outperformance in the last decade. Themes & framework: China’s peak in 2011 under Mercantilism (with Chinese characteristics) and the dissolution of the $Bloc/Chinese co-prosperity sphere ended the trend of falling US real rates they had created. But it wasn’t until Localization gathered sufficient steam – and the US private sector had deleveraged – that US openness and technological leadership sufficiently raised US returns to capital to support a rise in US real rates. The Trump administration’s political support (Politics of Rage) for Localization gave another nudge to US relative returns to capital, and Covid again accelerated these phenomena further (and likely more sustainably).

  • The capitulation of Saudi Arabia’s price leadership/management in 2014 in the face of surging US tight oil production leading to lower and more volatile crude oil prices. Themes & framework: The end of the commodity supercycle brought about by peak China under Mercantilism (with Chinese characteristics) paused relentless crude oil demand growth, allowing innovation and a business-friendly US regime to undermined Saudi Arabia’s price leadership with tight oil production. Cartel dynamics combined with Saudi Arabia’s long-run price maximization led to a collapse in Saudi-enforced OPEC discipline, and lower, more volatile crude oil prices.

  • Financial volatility’s shift to a lower median level with more frequent, shorter explosions during the last decade. Themes & framework: Rising Uncertainty in politics (Politics of Rage), geopolitics (Global entropy), technology (Localization), and policy (Missingflation) amid Complexity cascades shifted the relative shares of total risk away from quantifiable sources towards unquantifiable sources; the counter-intuitive implication of rising uncertainty is lower median volatility as active risk taking retreats in information lulls, with violent explosions of price activity when new information is revealed.

  • Persistence of post-Covid supply constraints and sustainable inflation supported by rearview-mirror central bank policies leading to a flip in the direction of Missingflation. Themes & framework: Covid simultaneously accelerated both the economic and political motivations for Localization, caused a permanent shift in the structure of global demand, and disrupted existing global supply chains. Short-run aggregate supply could not adjust to the jump in investment and shift in demand quickly enough, creating prolonged shortages and the need for prices to curtail demand. The associated cost-push inflation was all the spark needed to ignite Believing is being changes in inflation expectation driven by central banks’ backward-looking policies based on a lack of understanding of Missingflation.

  • The Fed’s post-Covid rate cycle would be more like 1994 than the post-2000 gradualist cycles (a call I made in early 2021). Themes & framework: The intent of the Fed’s FAIT policy always was to boost long-run inflation expectations by falling “behind the curve” on inflation. Yet their lack of understanding of the causes of Missingflation and insufficient faith in their own ability to generate Believing is being kept them focused on “fighting the last war” too long, allowing inflation to run too hot, too quickly. But contrary to market conventional wisdom, inflation is deeply politically unpopular in an aging society and no central banker wants to be remembered as failing to control inflation. Accordingly, the Fed (eventually) will react forcefully to contain the Believing is being genie they underestimated.

  • Consistent underperformance of European economy, assets and the euro since the Global Financial Crisis. Themes & framework: Relative to trend growth, Europe was more highly indebted than the US, yet European policymakers too long considered the GFC an “American problem”. Combined with Europe’s greater institutional rigidities and a reluctance to write down bad assets, it would take proportionately longer to achieve necessary deleveraging. China’s 2011 peak within Mercantilism (with Chinese characteristics) and the rise of Localization undermined all parts of Europe: the globalization-dependent South and China-dependent North, while inflexibility and low levels of technological innovation inhibit Europe’s ability to adjust to the new global economic order.

  • UK outperformance of consensus Brexit forecasts. Themes & framework: Consensus forecast for post-Brexit UK were based on three flawed assumptions (due to underappreciation of themes!). First, by ignoring emergent Localization, growth forecasts grounded in Apex neoliberalism wrongly assumed globalization would continue to be a major driver of economic growth. Second, the consensus failed to acknowledge the UK’s long-run structural competitiveness: world-leading universities providing a technological edge in Localization; and strong, enduring institutions offering safety and stability amid Global entropy and rising Uncertainty. Third, the consensus, ironically, ignored the largest driver of trade (by a wide margin) in their own models: “gravity”, or proximity to trading partners. Network effects are extraordinarily powerful in trade and difficult to overcome.

  • Importance and implications for markets of Scottish independence referendum in 2014. Themes & framework: As one of the earliest manifestations of the Politics of Rage and its demands for greater political representation, the Scottish referendum was an unanticipated shock to markets and one of the first signs of Global entropy and the Uncertainty to come.

Global entropy

Manifest and growing disorder

By ignoring the endogeneity of complex systems and Rodrick’s globalization trilemma – that democracy, national self-determination, and economic globalization cannot enduringly coexist – Apex neoliberalism sowed the seeds of its own demise, leading to today’s manifest and growing global disorder: the end of Post-World War II international rules, rising ethnonationalism, multipolarity, the Politics of Rage, and the unwinding of globalized supply chains. In short, Huntington’s Clash of Civilizations trumped Fukuyama’s End of History. Apex neoliberalism facilitated rising trade-to-income ratios, cross-border capital flows, intergovernmental cooperation, and intra-economy income inequality; while simultaneously lowering financial spreads, inter-economy income inequality, and inter-state warfare. Global entropy likely will reverse many of these effects.

Missingflation

Economists don’t understand inflation

What are economists missing about inflation? In the two decades before Covid, market analysts, academic economists and central banks consistently overforecast inflation; in the last two years they have persistently underforecast it. Enduring one-way errors are not “white noise”; they demonstrate bias and strongly suggest that economists’ current understanding of inflation is flawed. Demographics, globalization and technology help to explain some of the forecast miss, but significant omitted variable bias remains, most likely due to failure to explicitly incorporate Believing is being.

Believing is being

Self-fulfilling beliefs are real

Beliefs drive everything from asset bubbles, to debt dynamics, to crypto currencies’ values, to inflation and hyperinflations (probably Missingflation, too). Good economists understand this but often omit beliefs from models to simplify because of the difficulty in measuring beliefs. Unfortunately, too many bad economists copy those models without understanding the potential for omitted variable bias. The rapid social, technological, political, and geopolitical changes behind Global entropy and Uncertainty are swiftly shifting beliefs, driving a feedback loop of economic and political outcomes. Yet the infrequency of these deviations and difficulty in measuring them make statistical modeling nearly impossible. Only through economic theory and full-spectrum information collection can we infer when and how beliefs are adjusting and their likely effects.

Complexity cascades

Complex systems fail unpredictably

Human societies, nation states and (especially) economies are examples of complex systems. Complex systems always operate in “broken” mode and ironically are more structurally stable when they have lots of small failures. But when they are subjected to massive or cascading shocks, complex systems can fail unpredictably and totally. Covid and manifest Global entropy represent self-reinforcing mammoth shockwaves that imply systemic collapses – in all spheres, socio-political, geopolitical, economic, and financial – are more likely than the consensus admits.

Uncertainty

Not all risks can be quantified

All risks are not the same. Some are quantifiable, like the chance of being dealt an ace in a game of cards. Others are not but can be subjectively guessed, like the chance you leave a casino a winner. Then there is uncertainty, the most dangerous of all risks because it is by definition, non-quantifiable: what is the chance the casino gets hit by a meteor? Apex neoliberalism created a façade of quantifiable risks; Global entropy and Complexity cascades are illustrating that the world is far more uncertain. The quantitative models in finance, business, economics, and politics that gained dominance during Apex neoliberalism generally have performed poorly as Global entropy has become more pronounced, a trend that is likely to sustain as uncertainty rises further. Scenario analysis and “satisficing” are the only proven frameworks for dealing with uncertainty.

Politics of Rage

The proletariat want their franchise back

Four decades ago, globalization and increasing economic returns to intellectual capital opened a fissure between elites and everyone else, especially in more developed economies. The economic and political consequences of Apex neoliberalism widened this fissure into a chasm of mistrust that has resulted in the political turmoil that engulfed most advanced economies in the last decade. Contrary to conventional wisdom, its causes derive more from perceived and actual political disenfranchisement than economic distress and inequality. Trends in the former suggest the wave is not near cresting, implying sustained socio-political, geopolitical and economic disruptions.

$Bloc/Chinese co-prosperity sphere

FX herding cures “fear of floating”

The “co-prosperity sphere” of bloc managed exchange rates centered around Chinese trade and the US financial system, alternatively known as Bretton Woods II or Chimerica, dramatically reoriented global supply chains, supported emerging markets’ financial development and economic boom of the 2000s, drove much of the dollar’s 2002-’11 depreciation, and ultimately likely caused the Global Financial Crisis. Emerging market crises of the late 1990s marked the final chapter in the Bretton Woods exchange rate system. Yet “Fear of floating” persisted until China’s Mercantilism and contemporaneous accession to WTO provided an alternative: exchange rates managed by “herd” or by “pack”. Hiding within the herd provided financial stability for China’s EM trading partners, while simultaneously allowing them hunt as a pack for foreign direct investment and supply-chain dominance. The size and rapid growth of the co-prosperity sphere distorted the global economy like a massive stellar object warps space-time. Collective suppression of exchange rates and domestic cost of capital diverted supply chain growth into the bloc, while attendant reserve accumulation led to a surge in demand for “safe” core economy bonds. The former undermined returns to capital in traded goods production outside the bloc and the latter depressed interest rates on “safe” US debt, encouraging overinvestment in non-traded goods like housing. (Note: I labeled this phenomenon “the dollar bloc” when I first wrote about it in 2003-04, but later referred to it as “the co-prosperity sphere”.)

Mercantilism (with Chinese Characteristics)

State capitalism’s unintended costs

China’s 1994-2012 “miracle” that lifted nearly a billion people out of poverty and its current growth problems both originate in its extreme application of the mercantilist “Asian growth model” originated by Japan and later copied by Asia’s “Tigers”. A combination of capital controls, protectionism, domestic financial repression, and industrial policy direct underpriced capital to favored industries that promote rapid capital accumulation and development by leveraging external demand (and technology) from advanced economies. Rapid development and convergence comes at cost, however. Underpriced capital and exchange rates lead to distortive overinvestment. Those losses are realized either abruptly and painfully through write downs – like those enforced on late-‘90s Asian Crisis economies by the IMF – or, if the economy can self fund, are “amortized” as lost future growth. Japan’s lost decade and China’s current funk are examples of the amortization path of economic loss.

Apex neoliberalism

Liberal capital democracy’s pyrrhic victory

Rapid global growth, particularly in the less developed world, “hyperglobalized” production and the growth of inter-governmental coordination derive substantively from the triumph of neoliberalism that followed the collapse of its ideological competitors with the Soviet Union’s fall and emerging market crises of the 1990s. But so too did the seeds of its undoing: The Politics of Rage, Mercantilism (with Chinese characteristics), Missingflation, and ultimately Global entropy. Rapid adoption of Western economic institutions and trade mechanisms followed from neoliberalism’s victory, promoting a world of hyperglobalization: ever-more dispersed but integrated global supply chains, just-in-time industrial processes with reduced redundancy, unfettered cross-border capital flows, and uniform rules that increased the influence of international institutions, non-governmental organizations and multinationals at the expense of local political control and less-skilled citizenry. Resultant uniformity and coincident digitization created a façade of certainty and quantification, promoting an overreliance on quantitative methods in decision processes, risk control and forecasting.

Economic and market phenomena:

Economic & market forecasts
  • The continued fall in US real rates through the 2000s and early 2010s. Themes & framework: Mercantilism (with Chinese characteristics) and the associated $Bloc/Chinese co-prosperity sphere undermined the marginal product of capital in the US while simultaneously increasing non-US demand for US Treasuries.
  • Emerging market outperformance in the 2000s. Themes & framework: Mercantilism (with Chinese characteristics) drove both the development of the $Bloc/Chinese co-prosperity sphere and the commodity supercycle, while Apex neoliberalism supported institutional reforms that lowered EM risk premia, all of which encouraged foreign direct investment that raised productivity and led to rapid economic growth.
  • The end of emerging markets’ “original sin” and growth of EM local bond markets, a development supported by a G7 initiative that I led at the US Treasury. Themes & framework: The $Bloc/Chinese co-prosperity sphere provided a new stability in many EM exchange rates while institutional reforms undertaken by many as part of Apex neoliberalism lowered EM risk premia.
  • The Global Financial Crisis (albeit see admission of errors below). Themes & framework: Mercantilism (with Chinese characteristics) and $Bloc/Chinese co-prosperity sphere simultaneously increased incentives for debt finance in the US (as demand for “safe” USD bonds rose globally) while undermining US means of repayment as the US marginal product of capital in traded goods fell. Combined with poorly designed bank regulation that allowed banks to leverage themselves well beyond regulators’ intent (Apex neoliberalism), “complexity cascaded”.
  • The failure of QE to generate post-GFC inflation. Themes & framework: Believing is being: inflation expectations were stable to falling amid deleveraging and associated lethargic income growth, lowering real interest rates as nominal rates were pinned at the zero lower bound, and implying sustained weak money demand. Stuffing banks with more reserves changed none of those variables. As Keynes described seven decades earlier – in the absence of negative nominal rates – monetary policy at the zero lower bound is equivalent to “pushing on a string”.
  • The lack of effect of balance sheet runoff on interest rates. Themes & framework: Believing is being and portfolio theory rejected the then dominant “portfolio balance” theory of QE. QE was a credible commitment by central banks to keep rates on hold, suppressing expectations for future rates and thus the yield curve. This is why the “Taper Tantrum” had its largest effects on 3-5 year forward rates as expectations for rates hiked rose, while long-dated forward rates fell. Measures of long-dated term premia continued to fall as the Fed reduced its balance sheet.
  • Peak Chinese growth in 2011. Themes & framework: Mercantilism (with Chinese characteristics) led to unsustainable contributions of investment to GDP and a collapse in China’s marginal product of capital amid historically large debt to GDP, a phenomenon that peaked with China’s 50% surge in domestic credit in response to the GFC. Domestic funding of its debt trapped China within its own financial repression scheme, frustrating its efforts to unwind its $Bloc/Chinese co-prosperity sphere and internationalization the renminbi as a closed capital account is required to avoid savings flight and a collapse of the debt bubble. This self-funded debt bubble implies that losses from consequent overinvestment are “amortized” in the form of slower growth.
  • Emerging Market underperformance of the last decade (and likely future decade). Themes & framework: Institutional reform in EM peaked with US policy credibility before the GFC under Apex neoliberalism; China’s peak within Mercantilism (with Chinese characteristics) in 2011 and the associated end of the commodity supercycle ended the “pack” economic benefits of the $Bloc/Chinese co-prosperity sphere, while simultaneously the advent of Localization began to shift production back to advanced economies. Amid stagnating growth and backsliding reforms, EM FX and asset prices looked (and continue to look) overvalued and risk spreads remain too thin.
  • Falling USD reserve share in the 2000s and a rising share since peak China. Themes & framework: The massive reserve accumulation required to sustain undervalution of the $Bloc/Chinese co-prosperity sphere came to be seen as “sovereign wealth” that required diversification, rather than a liquidity store for crises, and led to a consequent fall in the USD share of reserves. Yet the greater financial openness and cross-border claims that accompanied the Apex neoliberalism necessarily implied a proportional increase in capital outflows in periods of risk aversion; i.e. historically large reserves were not as large as perceived in reality. As China and the $Bloc/Chinese co-prosperity sphere slowed after 2011, and Global entropy increased Uncertainty with attendant effects on risk aversion, emerging markets learned painfully in 2014 that reserves were neither excess nor sovereign wealth, but instead necessary liquidity, and that the USD’s safe haven properties were unparalleled.
  • Low and falling inflation throughout the 2010s. Themes & framework: Missingflation, the unexplained trend component of global inflation that had led to two decades of inflation overforecasting by economists, showed no signs of abating and seemed to be caused by a continued slide in inflation expectations (Believing is being) as central banks struggled with the zero lower bound. The end of the trend would require both for central banks to make more credible commitment to raise inflation in conjunction with a sustained positive inflation shock.
  • The (trend) bottoming of long-term US real rates, higher-than-expected peak in Fed funds rates and US equity outperformance in the last decade. Themes & framework: China’s peak in 2011 under Mercantilism (with Chinese characteristics) and the dissolution of the $Bloc/Chinese co-prosperity sphere ended the trend of falling US real rates they had created. But it wasn’t until Localization gathered sufficient steam – and the US private sector had deleveraged – that US openness and technological leadership sufficiently raised US returns to capital to support a rise in US real rates. The Trump administration’s political support (Politics of Rage) for Localization gave another nudge to US relative returns to capital, and Covid again accelerated these phenomena further (and likely more sustainably).
  • The capitulation of Saudi Arabia’s price leadership/management in 2014 in the face of surging US tight oil production leading to lower and more volatile crude oil prices. Themes & framework: The end of the commodity supercycle brought about by peak China under Mercantilism (with Chinese characteristics) paused relentless crude oil demand growth, allowing innovation and a business-friendly US regime to undermined Saudi Arabia’s price leadership with tight oil production. Cartel dynamics combined with Saudi Arabia’s long-run price maximization led to a collapse in Saudi-enforced OPEC discipline, and lower, more volatile crude oil prices.
  • Financial volatility’s shift to a lower median level with more frequent, shorter explosions during the last decade. Themes & framework: Rising Uncertainty in politics (Politics of Rage), geopolitics (Global entropy), technology (Localization), and policy (Missingflation) amid Complexity cascades shifted the relative shares of total risk away from quantifiable sources towards unquantifiable sources; the counter-intuitive implication of rising uncertainty is lower median volatility as active risk taking retreats in information lulls, with violent explosions of price activity when new information is revealed.
  • Persistence of post-Covid supply constraints and sustainable inflation supported by rearview-mirror central bank policies leading to a flip in the direction of Missingflation. Themes & framework: Covid simultaneously accelerated both the economic and political motivations for Localization, caused a permanent shift in the structure of global demand, and disrupted existing global supply chains. Short-run aggregate supply could not adjust to the jump in investment and shift in demand quickly enough, creating prolonged shortages and the need for prices to curtail demand. The associated cost-push inflation was all the spark needed to ignite Believing is being changes in inflation expectation driven by central banks’ backward-looking policies based on a lack of understanding of Missingflation.
  • The Fed’s post-Covid rate cycle would be more like 1994 than the post-2000 gradualist cycles (a call I made in early 2021). Themes & framework: The intent of the Fed’s FAIT policy always was to boost long-run inflation expectations by falling “behind the curve” on inflation. Yet their lack of understanding of the causes of Missingflation and insufficient faith in their own ability to generate Believing is being kept them focused on “fighting the last war” too long, allowing inflation to run too hot, too quickly. But contrary to market conventional wisdom, inflation is deeply politically unpopular in an aging society and no central banker wants to be remembered as failing to control inflation. Accordingly, the Fed (eventually) will react forcefully to contain the Believing is being genie they underestimated.
  • Consistent underperformance of European economy, assets and the euro since the Global Financial Crisis. Themes & framework: Relative to trend growth, Europe was more highly indebted than the US, yet European policymakers too long considered the GFC an “American problem”. Combined with Europe’s greater institutional rigidities and a reluctance to write down bad assets, it would take proportionately longer to achieve necessary deleveraging. China’s 2011 peak within Mercantilism (with Chinese characteristics) and the rise of Localization undermined all parts of Europe: the globalization-dependent South and China-dependent North, while inflexibility and low levels of technological innovation inhibit Europe’s ability to adjust to the new global economic order.
  • UK outperformance of consensus Brexit forecasts. Themes & framework: Consensus forecast for post-Brexit UK were based on three flawed assumptions (due to underappreciation of themes!). First, by ignoring emergent Localization, growth forecasts grounded in Apex neoliberalism wrongly assumed globalization would continue to be a major driver of economic growth. Second, the consensus failed to acknowledge the UK’s long-run structural competitiveness: world-leading universities providing a technological edge in Localization; and strong, enduring institutions offering safety and stability amid Global entropy and rising Uncertainty. Third, the consensus, ironically, ignored the largest driver of trade (by a wide margin) in their own models: “gravity”, or proximity to trading partners. Network effects are extraordinarily powerful in trade and difficult to overcome.
  • Importance and implications for markets of Scottish independence referendum in 2014. Themes & framework: As one of the earliest manifestations of the Politics of Rage and its demands for greater political representation, the Scottish referendum was an unanticipated shock to markets and one of the first signs of Global entropy and the Uncertainty to come.

Foreign exchange forecasts:

Foreign exchange forecasts
  • The dollar’s trend fall 2002-’11. Themes & framework: The effects of the $Bloc/Chinese co-prosperity sphere on relative returns to capital, balance of payments and the effects of “diversification” as sovereign reserves evolved into sovereign wealth.

  • The dollar’s trend turn in 2011, surge 2014-2016, and counter-consensus strength in 2018 and 2021 (I was the only sell-side analyst to forecast USD strength in 2021). Themes & framework: The same forces driving the US real rates higher in the last several years – the end of Mercantilism (with Chinese characteristics) and its associated $Bloc/Chinese co-prosperity sphere, disproportionate benefit to the US from accelerating Localization, Global entropy and Complexity cascades, all played out in the USD, too, with added support from increased safe haven demand for the greenback due to rising Uncertainty brought about by Global entropy and Complexity cascades.

  • The euro’s plunge from $1.36 in mid 2014 to $1.05 in early 2015. Themes & framework: Reluctant deleveraging from the Global Financial Crisis combined with the sharp deterioration in European returns to capital following China’s peak within Mercantilism (with Chinese characteristics) and the shift to Localization from globalization implied a sharply lower real value of the euro. When ECB President Draghi ruled out the deflationary (1990s Japan) path to devaluation with his commitment to “whatever it takes”, Believing is being implied an immediate and massive change in the nominal value of the euro was required as the expected path for domestic prices flipped.

  • The yen’s surge from above 120 per dollar to below 105 in H1 2016. Themes & framework: Abenomics’ biggest success was its Believing is being commitment to reflate Japan’s economy, leading to a sharp depreciation of the nominal yen as expected future deflation was unwound. But yen depreciation included an “overshoot” to compensate for the risks that inflation might overshoot. The Bank of Japan’s tacit admission that “Quantitative & Qualitative Easing” could not create sufficient inflation with its December 2015 adoption of negative interest rates implied a rapid unwind of the overshoot given the yen’s deep undervaluation as beliefs shifted again.

  • The pound sterling’s pre-EU referendum fall to $1.40, post-referendum floor near $1.20, and its post-Brexit rebound above $1.30. Themes & framework: A steep risk premium in sterling was required to compensate for the Uncertainty induced by the Politics of Rage driven jolt. Yet, 1.20 represented a 60+ year low in purchasing power parity and seemed to undervalue the UK’s long-run structural assets – strong institutions, top global universities, leading tech industry – all of which were appreciating in value in a world of Localization, Global entropy, broader Uncertainty, and rising potential for Complexity cascades.

Political forecasts:

  • Political instability in Russia and China in 2023: Clash of the Themes.

  • Brexit 2016. Themes & framework: The chasm between elites (including those in markets) and ordinary citizens over the latter’s sense of disenfranchisement, the fundamental cause of the Politics of Rage, was clear well before the referendum and strongly suggested that bias in polling turnout models could fully account for the polls’ projected margin of defeat.

  • Trump 2016. Themes & framework: Record pre-election postal votes from registered independents (for whom no party seeks to “get out the vote”) suggested that, as with Brexit, the Politics of Rage’s disenfranchised and unaccounted for voters would be sufficient to overcome the (narrow) projected margin of loss.

  • Marine Le Pen’s 2017 success in reaching the run-off but ultimate failure to win French presidency. Themes & framework: The Politics of Rage framework suggested an undercounting of both Le Pen and left-wing populists’ support, giving her a clear path to the second round. But her projected margin of loss in the general election was far too large to be due solely to turnout bias, implying no chance of second-round success, particularly with left-wing populist voters dropping out or shifting support to Macron.

  • Trump narrow loss, post-election conflict 2020. Themes & framework: Pollsters’ mistaken focus on education levels as the source of their 2016 turnout errors rather than on (mis)trust driven by the Politics of Rage implied polls still were biased. Large shifts in minority voters towards Trump and unusually high “undecided” voters late in a highly polarized election also suggested the magnitude of Trump’s outperformance would be large (indeed, it was larger than 2016). But the margin to overcome also was much wider in 2020, suggesting a close loss by Trump. Increasing polarization and mistrust on both sides implied a violent reaction by a minority, whichever side lost.

Admission of errors:

I get things wrong, too, but hopefully am the wiser for it. This list is far from complete, but represents some of the ones that both stung and taught me the most.

  • Failing to specify financial institutions as at risk from credit trauma in 2023. While I did highlight that the most predictable source of for 2023 would be credit events following the massive rise in interest rates in 2022 (Debt reality versus perceptions), I didn’t specifically identify banks and other financial institutions as especially vulnerable, which proved to be the case with the failure of a few regional US banks in March 2023. Lessons learnt: Sometimes one’s focus on the underlying causes blinds to the obvious consequences, and levered entities with broad exposure will always be at risk from any traumas within an economy, even if sector or region specific.

  • Not seeing the Global Financial Crisis sooner. I saw the GFC earlier than many, but the extent of the financial system’s capital shortfall eluded me far longer than it should have. At the US Treasury from 2006 through early 2008 I was responsible for assessing foreign financial risks (sadly, institutional territorialism prevented an integrated approach with my domestic-side colleagues that may have focused more attention on off-balance-sheet financing of US housing). I chaired meeting after meeting in 2006-‘07 with market professionals, academics, regulators, and other policymakers where a noisy minority of participants argued that historic levels of debt to GDP implied an impending crisis. Yet when I challenged them to explain a channel of transmission, what would be the tipping point, why it had not occurred already, or to present evidence that bank capital was insufficient to absorb even an historic drop in US housing prices, none – including some who have become very famous for “calling” the GFC – could do so. Ultimately, it was the behavior of banks in funding markets in mid-to-late 2007 that clued me in that banks’ capital bases might not be what they purported (or, equivalently, contingent liabilities off balance sheet were far larger than people understood). What I had not done – nor, apparently had any of the “experts” I consulted in those years – was the detailed micro-level analysis that the protagonists of The Big Short had done (kudos to them). Lessons learnt: 1. “Macro” analysis often requires “micro foundations”; 2. many people claim expertise, don’t rely on it without evidence; and 3. notwithstanding (2), even if they can’t explain it, pay attention when a gathering minority claim to smell smoke. (Implicit lesson 4: don’t assume that the left hand is talking to the right hand in any organization.)

  • Losing my nerve at the bottom of markets in 2009. My framework helped me to correctly call the bottom in credit markets in January 2009 and recommend to the distressed debt fund I then worked for that we aggressively buy leveraged loans. But on market research mission in late February, I got spooked by US Treasury and Fed officials I met in New York and Washington. Throwing my framework out the window, on 6 March 2009, the exact day the S&P 500 hit its 666 low, I wrote a memo urging the fund to sell SPX futures as a hedge on its market exposure. Lessons learnt: 1. Never abandon your framework; and 2. don’t assume someone’s position or pedigree alone gives them an informational or analytical advantage: demand reasons and evidence.

  • Missing the euro’s partial rebound in 2017; indeed, I forecast it lower! I failed to acknowledge the extent of the uptick in economic activity, and importantly, the credit growth that the ECB’s “anything it takes” policy was generating. This one stung as I was a strong believer in then-President Mario Draghi’s approach and had previously highlighted credit expansion as a key metric of success. Lessons learnt: Keep your eyes on the ball and regularly check to see if any of the ex ante conditions established for changing your mind have been met.

  • Dollar weakness in summer 2020. Another one that really stings. Having correctly forecast that Covid-induced Uncertainty would lead to a surge in the USD as everyone scrambled for high-quality assets and liquidity in March-April 2020, I then failed to incorporate the unwind of that flight to quality as risk tolerance returned once the panic subsided. Lesson learnt: Sadly, the same as 2017 dollar lesson: Keep your eyes on the ball and mind your pre-established conditions for turning points.

  • I completely missed the Fed’s mini easing cycle in 2019. While we will never know and Covid eviscerated my chance at redemption, I still believe the Fed’s easing was not merited and likely would have necessitated more aggressive hiking later had the Covid crisis not intervened. The US economy continued to grow strongly in 2019, investment held up, and while headline inflation moderated somewhat, bottlenecks were generating rapid acceleration in a number of CPI subcomponents. But even if I was right on the economy, the FOMC sets policy and I failed to listen to them, particularly the increasing support for average inflation targeting. Lessons learnt: Policymakers set policy, listen to them even if you think they’re wrong.

  • Underestimating Jeremy Corbyn in the 2017 UK general election. I expected a small Conservative victory based on then Prime Minister Theresa May’s outreach to the working class and the Labour Party’s anti-Brexit tone. What I failed to notice was that Mr. Corbyn’s grass-roots campaign cleverly focused on local bread-and-butter issues and greater political devolution, directly addressing one of the primary drivers of the Politics of Rage: a widening sense of political disenfranchisement among the average citizenry. Corbyn’s tangible policies and outreach – which he largely abandoned in his losing 2019 campaign – easily trumped Ms. May’s intangible rhetoric as “hidden” Brexit voters didn’t trust her. Lessons learnt: Again, “macro” analysis needs “micro foundations”, particularly in politics; ignore at your own peril.

  • Texas Governor Rick Perry to win the 2012 Republican nomination and beat President Barack Obama in the general election. The foundations of the Politics of Rage were already well apparent by the 2012 election and Rick Perry’s campaign was well tuned to court the rising sense of disenfranchisement of working-class voters, particularly in Appalachia, and increasing distrust of institutional expertise across voters. Many of those voters were Democrats who were disappointed with the lack of “Hope and Change” promised by President Obama, making him vulnerable to any Republican who could attract a significant number of Democratic voters. Governor Perry’s bigger challenge appeared to be winning the Republican nomination, but his solid conservative credentials and popularity in the second-largest state suggested he would eek it out. Who knew he would self-immolate in a nationally televised debate? Lessons learnt: Themes are important – Trump proved the Politics of Rage four years later – but idiosyncratic risks always are present.