First Republic Fall Forum Session 3: Global Geopolitical Landscape Leading Into the U.S. Election

First Republic Bank
October 7, 2020

Watch the second half of our Fall Forum: a series of conversations designed to explore the geopolitical landscape, U.S. presidential election implications, and key tax and investment considerations. Brought to you in partnership with Eurasia Group, one of the  world’s leading global political risk research and consulting firms. Learn more about Eurasia Group here.

Read below for a full transcript of the conversation. 

Susie Cranston - Good afternoon, everyone. Thank you for joining us here today, my name is Susie Cranston. I am the executive vice president for First Republic Investment Management Business. It's my pleasure to welcome you here today on behalf of First Republic. This is the third in a series of events we are calling the Fall Forum. Our forum events are focusing on the geopolitical landscape, US presidential election implications, and key tax and investment considerations. We are delighted to partner with Eurasia Group for today's program. For those of you who are new to Eurasia Group, political scientist, Ian Bremmer founded the advisory firm over 20 years ago to help business decision makers and investors, better understand how politics move markets. We are very fortunate today to be joined by David Gordon, former chairman of Eurasia Group. David spent more than 10 years working at the highest levels of US foreign and national security policy processes, providing clients with his perspective of US and global macro issues from Washington. From 2007 to 2009, David served as the director of policy planning under Secretary of State, Condoleezza Rice. He played a leading role in developing policy ideas for rights, on issues ranging from Afghanistan and Pakistan to US engagement in East Asia, to the multilateral response to the international financial crisis in 2008. He also led the department's strategic policy dialogues with more than 20 countries around the globe. Consistent with David's expertise, today's discussion will be focusing on global macro politics. This topic we feel is relevant for a number of reasons right now. First, there are a particularly large number of elections this year. Two, we are all watching the rise of nationalism globally and three, the frequency with which geo-political effects are manifesting and capital markets is increasing, as we've seen with Brexit, Russia, Crimea, US and Hong Kong. I'm going to start today with a number of questions for David and then we'll take questions from the audience. But, please note that throughout this conversation, you can submit your questions using the Q&A function at the bottom of your screen. You should see a little Q&A button and we'd love to have questions from the audience, so please submit them as they come. And I'll start, David, first by saying, again, thank you for joining us today.

David Gordon- Glad to be here with you.

Susie- Well, it is our pleasure and perhaps we could start with a survey of the state of view politics today and the G-Zero World we live in. How are you seeing things today?

David - Well, I think that the COVID pandemic has really reinforced the fact that we're in this G-Zero World. So, the pandemic began in China, but China has not been transparent about it. The US has really avoided getting involved in a leadership role in bringing the global community together around it, rather the president and the administration is taking a more nationalist view of this, particularly when it comes to things like vaccine development and all of this. So, I think that what we call the G-Zero World is a world in which the US is no longer willing or really able to give the leadership that it did since World War II and no other individual country or groups of countries are able to fill in effectively behind it. So in 2020, we have the pandemic, we have increasing tensions between the US and China, we have a very challenging global recession and most importantly, frankly, we have the COVID pandemic whose numbers continue to rise. Now, a lot of countries in the world have been stabilized around this, but some very big countries, most significantly, India and the US, continue to have numbers in the US around 30 to 40,000 today, sometimes even more and close to a hundred thousand a day in India. So, when I look at the world out there, it's not that pretty a picture. Now, that doesn't mean that you can't still find spots to invest in and all of that and we'll go into it, but not a very pretty picture.

Susie- Yeah and at the highest level, David, as you look towards 2021, do you see COVID as the continuing driving force as we head into next year, or do you look at these different factors? Or how are you seeing things shaping up as we head into the tail end of this year and into the next?

David- That's a really good question. So, I actually think that the COVID element itself is likely to begin to fade over the next six months, largely driven by the fact that I'm reasonably optimistic about the outlook for a vaccine. So, I do think that a vaccine will change that dynamic and so that's a pretty good news story. I think that the outlook for the world economy, I suspect is going to be a little bit better in 2021, driven by the fact that what goes down, has to come up and we've had a really sharp drop. And as long as the COVID element has been so present in so many places, it's really been impossible to have a V-shaped recovery. I think we begin to get more of a V-shaped recovery, particularly in the third and fourth quarters of next year. But, on the other hand, you have these really troubling things going on in the world. You have a very, very aggressive approach by the United States to the technology competition with China. I don't think it's likely to change, independent of the outcome of the US election. You have China going a bit crazy around the world, frankly, and mishandling, I think, a lot of goodwill that it could have created by really defeating COVID domestically and beginning to move into an economic recovery stage. And then you have all these elections that are going to be quite challenging. So, I think COVID comes down somewhat, but you've got a lot of stuff going on that's not going to be easy.

Susie- Yeah, a lot of variables that are still in play, now that makes sense. Well, given that this is a macro-level conversation, I was wondering if we could talk in a little bit more detail about some of the specific geographies and perhaps start by talking a bit about Europe. We'd love to hear your thoughts on Brexit and the consequences for Britain and Europe as that moves forward.

David -The good news is that I think the odds of a trade agreement coming together between the EU and the UK, have really increased. And I think that the signal just last week that prime minister Johnson and the head of the European Commission, Ursula von der Leyen, are going to start face-to-face negotiations, that has to be a good news story, they were not going to do that if they weren't close. Now, I think this is going to be a trade bill light. It's really going to be a lot of a least-common-denominator type of an agreement. I think the fact of the matter is, that the UK is not going to be nearly as integrated into Europe as it used to be. And it's almost inconceivable to me that the UK won't pay a cost for that. Now, the UK has one really important thing going forth though and that is that finance is the major sector in the UK economy and English is still the language of big global finance, so I think that the likelihood of Frankfurt, let alone Paris, really becoming a major financial center, is going to be limited by the fact that London has the English language going forward, that is going to slow down the exit of financial firms from the UK. But, I think that the UK is going to find itself in a weakened position. I mean, it had this very good structure in between Europe and the US because it was part of the EU. UK outside of the EU becomes much less of a key partner for the United States, so that will be negative. So I think that the outlet for Europe, is going to be much less driven by the UK. I think here, the bad news is that France and Spain, not the most important countries, but important countries in Europe, are really facing the second COVID wave now. The big thing to watch in Europe in 2021, is going to be the German elections. And I think it's more important than a usual German election for two reasons. One, Angela Merkel who has dominated German politics and dominated European cooperation efforts for over a decade, will be stepping down and she is going to be very hard to replace, both in Germany and especially in Europe. She was the individual who brought Europe together whenever key decisions had to be made. Secondly, is that it looks like we're heading to an unusual government that will be a coalition between the conservative parties, the Christian Democratic Union and it's even more conservative partner from Bavaria, the Christian Social Union and the German Green Party. And I don't know how that's going to work, that's not going to be easy to make work and it's going to take a while and Germany's not going to be focused on Europe. So, the kinds of efforts that we saw this year with the creation of the big stimulus package for Southern Europe, I just think that momentum is likely to be lost here and so Germany will be the big thing to watch. I'm not worried about Germany domestically, they'll work things out, but without German leadership, Europe finds a very hard time in going in without them. Now, French president Macron would love to step in and become the major player, but France it's really doesn't have the financial capability to do that and Macron really needed Merkel's diplomatic approach to make their cooperative efforts work.

Susie - Yeah, so, I think that is really fascinating and I can't help but wonder, given sort of less clear power structure in Europe, how do you think Russia is viewing this?

David- What the Russians have to worry about right now, is one very big thing and that is that their gas pipeline to Europe, the so-called Nord Stream 2 Project, I think could very well end up not being completed. And Merkel has been a very big supporter of Nord Stream 2, but the poisoning of the Russian opposition figure, Alexei Navalny, got her to even say, unless the Russians clean up their act, we're not going to do this. I think the next government could very well be less friendly to the Russians, so German politics is going to be a problem for Russia. And Russia still has a lot of places to make mischief, particularly I believe in South Eastern Europe. I think that's much more likely to be the focal point of Russia's efforts, but it's doing so from a position of weakness now. It looks to me, as if we're going to be in a low-energy price world for probably at least two more years. And Russia has very conservative fiscal and financial policies, they're not in huge trouble. On the other hand, the Russian economy is really being hurt pretty badly by low-energy prices and they utterly failed to transform their economy into a better-balanced economy that would be less vulnerable to these situations.

Susie - Well, let's shift maybe from Europe to Asia for a little bit. We read a lot about the unrest in Hong Kong and their fight for democracy and I'm curious where you see that going and what your thoughts have been.

David - I think that the outlook for democracy in Hong Kong is really pretty grim, to be very honest. The whole world accepts Hong Kong as a part of China, so China's sovereignty over Hong Kong is not questioned, this is sovereign Chinese territory, everybody admits that. And so, the fact that China has pretty blatantly walked away from the commitments that were made to Hong Kong in the 1997 agreement with the UK that transferred control over Hong Kong from the UK to China, at the end of the day, the rest of the world can't do much about that. And I think, basically, what I see happening in China now, is a new interest in really taking these geographies that were historically a part of China and reintegrating them. Now, for most of those geographies, it's not an easy thing to do, for Taiwan, we'll talk about that in a few minutes, for the Himalayan territories that are in conflict with India, but with Hong Kong, it's pretty straightforward. Now, the Chinese will pay something of a financial cost to that, but not anything like the cost they would have paid when the transfer from the UK to Chinese control was made. Hong Kong was a huge driver of China's economy, it's not anymore and China has other cities, including both Shanghai and the sort of sister city that's grown up very close to Hong Kong called Shenzhen, that can pick up those pieces. So, I think that we're just going to see the inevitable erosion of democracy in Hong Kong. Now, I think that the Chinese are being pretty stupid about this. If I was China, I would do this very gradually, very slowly, time is on their side, Hong Kong can't escape, it's not like Taiwan that I think the Chinese are realistically worried about, Hong Kong had no such capability. And in fact, I think China has undermined their reputation in the world by moving as aggressively as they're doing in Hong Kong, but I don't see that changing.

Susie- Well and you mentioned that you've seen several challenges or mistakes that China may be making. If we take a step back, it seems like their Belt and Road Initiative is on track, but they have weak GDP, which is creating challenges, as you've said, some of the aggression they're showing in trying to integrate areas like Hong Kong have been challenging, so how do you see all of this evolving, where is this heading?

David- It's a very good question. So, I think that China is really rethinking, how does it relate economically to the rest of the world? And for 30 years, since the opening up again in China, their strategy has been to sort of maximize engagement with the rest of the world, as a strategy to promote their own economic development, they're upgrading technologically and the creation of a middle-class society, right? And I think now that they're a good way along towards that, they're really rethinking this and I think China's actually beginning to turn inward. I think that president Xi Jinping outlined this new economic development strategy called the dual circulation economy. And if you dig into it, it really amounts to putting the primacy on the domestic economy, on domestic economic development, it's not cutting and decoupling from the rest of the world, but the primacy now in China is going to be internal and I think that will come at a cost to China. China has gotten enormous benefits from its engagement with the world economy over 30 years and it frankly has a lot still to gain, but I think it is just worried about losing control, losing the degree of autonomy that its leaders wish to have. There's a real parallel, in my view, between president Xi and the dual circulation economy strategy and president Trump and trade assertiveness against US partners and limitations on capital flows, inward and outward. I think that the most challenging issue for the world economy now, is both the two biggest economies in the world, are no longer nearly as committed to a global approach, than was the case even five years ago.

Susie- And as China seeks allies for its piece of the pie, so to speak, do you see it looking to partner with other countries, do you think it's going to try to assert sort of a dominant, how do you see them approaching that challenge?

David- So this is one of the very strange things that's happening. So, if you look at China historically, the notion of partnerships and alliances has never been that strong, in terms of China's thinking. China's notion of itself was always as the middle kingdom, the key country and the relationships it sought to build, were relationships of tribute. And so, in the last six or eight months, China has mishandled its relationships with at least five or six big key countries in the world, with the UK over Hong Kong, with Germany over Chinese involvement in the Belt and Road Initiative in Eastern Europe and especially in Southeastern Europe and other technology issues with Australia over the trade aggressiveness when Australia made-- Just ask these questions that every country is asking about the origins of COVID, with Japan over increasing Chinese tensions and activities in the East China Sea and then most recently with India with the military set in the Himalayas. So, these are big countries, all of whom were friendly with the US, that China had nonetheless established pretty good relationships with and now it is apparently moving to weaken all of those relationships or not acting in a way that reinforces them. So, I believe that there really is a premature hubris going on in Beijing about its ability to have its way in the world. Now, China, there's no question, China's a big rising power, but it's now frightening countries. And the only countries it has very, very, very close and very, very friendly ties with, it's a club that you don't want to belong to, North Korea, Myanmar, Laos, Cambodia, Serbia, none of them are allies that give a lot additionally to China. And that's one of the interesting paradoxes about China's rise that I think the conditions have been pretty good for China to increase its influence, but they're not acting in a strategic way around this, up to this point.

Susie- Yeah, one last question, before we move onto the middle East and I promised all of our viewers that we will definitely talk about the US, I know there's a number of questions, but a number of people have asked about South China Sea and what might happen there and what impact that might have on the global economy. So could you elaborate a little bit on that?

David- So, the South China Sea, China drew up a map about 12 or 14 years ago, that has been called the Seven-Dash Line map, in which they create this very expansive zone in Southeast Asia and the South China Sea that they consider to be China's sovereign territory. No one else considers that to be Chinese sovereign territory. And what's happened in the last few years, is China has begun to build up these islets in the South China Sea, including putting military facilities on a number of them. In response, the US and other countries have begun to engage in what we call FON, Freedom of Navigation Operations, that's sending small flotillas of ships through this territory, not seeking any kind of a confrontation, but just letting them know that we consider this open ocean where no country has sovereign rights. Is this going to turn into a confrontation? I'm a skeptic. So, my view is the big thing to worry about with China and the big thing to worry about a US-China confrontation, is Taiwan and that is definitely getting more challenging. Taiwan is the biggest and the most significant of these places, which China sees as its sovereign territory. And I think that that over the next several years, I expect tensions around Taiwan to really escalate. South China Sea will remain conflicted, but I don't see either the US or China having any real interest in going head-to-head there.

Susie- Yeah, so as I said, we've got quite a few questions about the US but I don't want to skip the middle East because there is a lot going on there. So could I ask, maybe David, could you share, what you see as sort of some of the biggest takeaways right now and I know there's a lot between UAE and Israel and Iran and Armenia, Azerbaijan.

David- So, a couple of things. So the first thing and the good news here, is that you've really now begun to see what I think is going to continue with a whole series of countries in this part of the world, recognizing Israel. And I think a lot of that is driven by the fact that for these countries, they just perceive much more of a challenge from Iran, than they do from anything going on in Israel. And the Palestinian issue doesn't have anything near the salience it once add in most of the rest of the Arab world, so that's issue number one. Issue number two, is Iran. Now, I'm very much of the view that we are likely to see a big move by the Trump administration to extend and expand economic pressures on Iran in the run up to the election. Most people are focusing on, what might Trump do with China? I don't think it's going to be China, it's too dangerous. I think it's going to be Iran and I think it's going to be a very big move to impose additional secondary sanctions that will sum up to almost a complete economic embargo. It won't be enforced by any kind of blockade, but I think that you're likely to see the creation of an economic embargo in the coming days and weeks against Iran. Iran is playing now from a position of weakness, they've been hit very hard by COVID, their main ally in the middle East is the Hezbollah Terrorist Movement and in Lebanon that has been undermined by the fact that it's probably implicated in some way or another, not in causing the explosion, but in holding the materials that exploded in Beirut. Third big issue, is Turkey. If China is aggressively asserting itself, Turkey, even more so in Libya, in Syria, in the Eastern Mediterranean, but the Turks are playing from a very big position of weakness. So, I think one of the most significant things about next year, is going to be that financial pressures on emerging markets are going to increase. The most vulnerable, by far, is Turkey and I would be very surprised if Turkey avoided a major financial crisis. So you have Turkey on the financial side, you have Iran, an important player, but weakened and then you have the really positive move of increasing ties between some of the key Arab States and Israel.

Susie- That was a fantastic overview, thank you, David. So, as we move to the US, our last of the geographic tour we're doing here today, I think a real-time question that many of us have on our minds is, what are your thoughts on today's stimulus proposal rejection?

David- I was caught a little bit by surprise because the discussions between Secretary Mnuchin and Speaker Pelosi, seemed to be gaining momentum, but the president decided to put a kibosh on this. I think in the context of the polls moving in favor of Biden, the president thought that this would just feed that momentum and he wants to stall and reverse that momentum, so I think that's what drove it. I do believe that no matter what the outcome of the election, there will be a move to another stimulus package, probably even as early as in the lame duck session of Congress following the election. But, I think that's what went on today, the president saw momentum building for Biden and he thought that this would play into that trend. He needs to shift that around.

Susie- Yeah. And, obviously, the elections are on everyone's minds, everyone is trying to understand what that means. What have you been thinking in terms of how the market is potentially pricing the election results in?

David- I do think that the market is increasingly pricing in a Biden victory, that's what it looks like to me. Right now, it's very, very hard to see a clean Trump victory. By clean, I mean something that will be broadly recognized, including by opponents, as being legitimate. That's not because I don't believe Trump might win the election, he might win the election. I think the odds are still, I don't know, three to one or something along those lines, but I think that he's unlikely to win it decisively enough, whereas the potential for Biden to win decisively, is out there. He may not, but I think what the market is pricing in just in the last few days, it is less of an inevitability of having a conflicted outcome.

Susie- Yeah, another great question that we got from the audience was, we've seen what US-China relations looks like under Trump. What do you think that it might look like under Biden and would we see this continuing separation or do you think that might look different?

David- That's a really interesting question and one that I'm asked all the time. So, my own sense is that on technology, on technology, there's not going to be a big shift. I think we are heading towards tech decoupling, competing tech systems, so I think that element of it will be marked by continuity. The Biden key China advisers, are actually quite hard-lined on China. On the other hand, there still are a lot of voices on the democratic side, who are spending now a lot of time looking at the history of the cold war, in terms of, how did we get things like arms control agreements between the Soviet Union and the US? What was it that we were able to do during the cold war that created the outcome where all of the military engagements were really in very faraway places to the central interests of either power in Africa or the poor parts of Southeast Asia? So, there is, I think a lot of interest in looking at, if we're going to have this tension and conflict, how can we move to bounding that because the Biden administration will want to work with China on climate and on other issues. So, I do think that, yes, the tensions around technology definitely continue, I think the overall orientation isn't going to be all that much different, I think the expectations are that this US-China competition will dominate, but I think the Biden team, especially on climate, is going to want to find a way to engage with China.

Susie- Yeah, another area that we haven't spent as much time talking about, is emerging markets and we'd love to hear if you have any thesis themes about which emerging markets might outperform the US market in the next year.

David-I do think things get tougher for the emerging markets next year. So, my view is that for the developed countries and for a lot of countries, we will be in a steeper recovery. For financially-weak emerging markets, that's not going to be very good, that's actually going to be bad because I think part of the reason that emerging market countries were able to continue to go to market as they have, is that investors couldn't see the ability to make money in the developed markets and I think that's going to shift, that will be negative. By far, the most vulnerable is Turkey, other countries to watch are South Africa that is also quite vulnerable, Brazil that is quite vulnerable, Mexico. So I do think that this year, I think, has been better than expected, in terms of continued access for a much bigger range of emerging markets to commercial finance than I thought was going to be the case. But, I think that the overall improvement in the developed countryside, is going to create a more negative consequence, particularly for countries with fragile finances. As I look at this right now, Turkey is almost in a class by itself there though.

Susie-Wow, well, we are running on time, but there is one last question that I told you I was going to ask that I know that is on a lot of people's minds, which has to do with president Trump's recent COVID diagnosis. What is your view in terms of the impact that may have on the campaign in the coming weeks here?

David- I mean, the last week was not a very good week for president Trump, the beginning with his just unbelievable performance in the debate a week ago and then with his being diagnosed with the virus. So, president Trump has to find a way to get traction with some new messages. Now, he's trying out some messages that I think a pretty good ones. I think the message of don't let the virus control us, I actually think that's a pretty good message. The media making fun of it, I think the media is wrong, I think that's a pretty good message. But, I think that he also, while stating that, he's got to find a way to reconnect, particularly, with suburban voters who just look at this and I think it's like, what were they doing in the white house not social distancing, not masking, treating this as if it was something that was either not at all threatening or if it happened, wouldn't disrupt things? So he has to reboot and he doesn't have a lot of time and we don't know how he is. So, he's actually, in terms of the flow of the disease, he's in early phases still. He's done well, thank God, but he could have another bout of illness in this.

Susie- Listen David, I have to say that every time I've had the privilege of speaking to you, I wish that we could talk for another hour or two at least. You have a wonderful handle on what's going on in the world and I'm sure I speak for everyone when I say we really appreciated your time today. I also want to thank everyone who joined us for this session and if anyone would like to watch a replay, we will have it available at firstrepublic.com/online hype and events and the first two events of our fall forum were there as well. Our final fall forum session will be Tuesday, October 13 and we hope that you will join us again then. So with that, I will thank you all again for your time and look forward to talking again soon, take care.

David- Thank you very, very much. My pleasure everybody.

The guest speaker(s) is neither an employee nor affiliated with First Republic. Opinions expressed by the guest speaker(s) are solely their own and do not necessarily reflect those of First Republic. This information is governed by our Terms and Conditions of Use.