The High Man In The Castle

By Michael Every of Rabobank

The world is again waiting to see what comes out of US-Iran peace talks in Pakistan as the two-week ceasefire deadline looms. Again, it’s a binary outcome: war, with threatened strikes on bridges and power plants in Iran, then perhaps regionally, and an extended closure of Hormuz; or peace, and energy and key goods flowing again.

The markets have decided peace will be the outcome. Because markets. Yes, there are times when bad news logically justifies a rally, e.g., in a real threat of nuclear war, go long: it may not happen, and it can’t hurt if it did. However, when the threat is painful and potentially long-lasting, but not existential, does that logic hold? If so, why bother with geopolitical analysis (and many market participants don’t)? Everything works out in the end, you can’t afford to be the only fund manager who misses the inevitable rally, so just ‘buy all the things.’

Philip K. Dick’s ‘The Man in the High Castle’ is set in a 1962 where the Axis won WW2 and an occupied-US underground shares that on another plane of existence, things worked out differently. They are led by the ancient Chinese Book of Changes, the ‘I Ching’; today, markets view all existence as led by ‘I kerching!’ Yet both views can be flawed. The ‘reality’ where the Axis lost WW2 is also not our world – rather, the British Empire under Churchill is gaining the upper hand in a global struggle with the US. Nobody knows what happens next with Iran.

Is Mr Market ‘The High Man in the Castle’ in thinking everything always works out for him? Is whomever the actual Iranian decision maker the same if thinking the US won’t pull the trigger again if there is no deal, and that Iran wins from that pummeling? Is President Trump if supposing the Iranians are rational rather than theological? We may not have long to find out.

For those who pay attention to geopolitics, there are some potentially optimistic signs. In the Middle East, China’s Xi held talks with Saudi’s MBS and made clear Hormuz needs to reopen. At the same time, Pakistan was told not to send a $1.5bn order of weapons to Sudan, which the Saudis were paying for, and a $4bn deal for the Libyan National Army is also on hold. Likewise, another round of Israel-Lebanon talks are set for Thursday to try to extend their ceasefire, which Iran links to its own, as Syria is cracking down on Hezbollah. Even the European envoy to the Gaza Board of Peace is publicly optimistic about Hamas disarmament talks.

In Europe, Ukraine may be seeing a ‘the EU hopes to realise its €90bn Ukraine loan within 48 hours following the new government in Budapest. However, the new pro-Russian Bulgarian PM may see things differently alongside the Czech and Slovak leaders, while Romania’s government looks about to fall.

Moreover, the EU is bracing for delays to promised US weapons shipments due to the Iran war, as The Times says the UK isn’t seizing Russian shadow fleet tankers in its waters because berthing and maintaining them could cost too much(!) Meanwhile, France and Germany are said to be considering proposals to give Ukraine only “symbolic” benefits during a normal EU accession process, without granting Kyiv access to the EU’s common budget or voting rights. In the same way there may be only symbolic weaponry if the US isn’t able to step up? That’s as the Wall Street Journal notes, ‘In Germany, Everyone Is a Defence Manufacturer Now’ as firms “scramble to reinvent themselves as military vendors to tap into the country’s accelerated rearmament.”

There are also further US-Europe tensions. The US just signed a military defense agreement with Morocco, which some suspect may soon host US military bases now located in Spain, which has been a loud anti-US voice under its current PM; that might suggest the US ability to threaten the Strait of Gibraltar in line with its other recent agreement with Indonesia vis-à-vis the Strait of Malacca. The White House is reportedly also looking at a report that backs Spain having to hand back Ceuta and Melilla, territories it holds in Morocco. German Chancellor Merz has also stated that Cuba poses no risk to third countries, and he does not see on what basis an intervention should take place – which will infuriate the Americans and do nothing to stop them if they intend to act on that front. (Which seems likely.)

There are tensions in the Americas with Canada too, whose PM just stated that close economic ties with US are “a weakness that must be corrected.” He is also talking about boosting his armed forces – though the scale of the imbalance there should be clear when a headline today boasts, “Canadian military beats recruitment target after 1,400 permanent residents sign up.”

By contrast, as Trump pushes a $1.5trn Pentagon budget, China sends warships to the Pacific while Japanese forces take part in exercises with the US and Philippines. Meanwhile, the crisis in Hormuz has seen Thailand’s government to push ahead with its Landbridge project to connect the Andaman Sea to the Gulf of Thailand via new ports on each side connected by a railway and highway, in order to circumvent the Strait of Malacca. The project is seen as making little economic sense by the logistics industry, but that doesn’t mean it might not make geopolitical sense to some players – and then draw the attention of others.

On the trade front, China has released new regulations to counter the “unjustified” extraterritorial use of foreign laws, aimed at protecting its interests. This is seen as clashing with the EU’s proposed regulations in this area, placing European firms in China in potential conflict with either one or the other. The European Chamber of Commerce in China has raised concern that the “broad scope, vague language and wide discretion” of the new Chinese rules goes far beyond similar statutes in the West.

Yet if you are all about Mr Market then none of the above matters; all that does is today’s Senate confirmation hearing for FOMC Chair nominee Kevin Warsh. Then again, once upon a time, these were dry affairs for dry men and women, but not in our present reality. Even the Financial Times is carrying an op-ed arguing that the Fed needs to reinvent itself and its mission; but they are thinking more along the lines of ‘how much dot plot’ rather than ‘how do you finance a $1.5 trillion Pentagon budget?’, ‘How do you force dollar stablecoins on the world to boost fiscal space?’, and ‘What are central banks *for*?’

More narrowly, Warsh’s finances, which he has lots of, are seen as a potential line of attack for those opposed to his appointment: it’s not so much that he’s very rich, which is the assumed norm for Fed Chairs, but that some of those holdings might be opaque. Because we couldn’t have any vested interests represented in Washington D.C., obviously. That would be unthinkable.

Ask yourself what the version of you would have thought of these headlines in April 2016. Then ask yourself what you think they will read like in April 2036. Only then decide what to do.

“Can anyone alter fate? All of us combined… or one great figure… or someone strategically placed, who happens to be in the right spot. Chance. Accident. And our lives, our world, hanging on it.” – The Man in the High Castle.