“Prenez un grip. Donnez moi un break!”, Boris was moved to exclaim in the face of French fall-out from the Australian nuclear submarine row. Last week we referred in this column to the brewing brouhaha from the new AUKUS defence pact and France being dropped as the strategic supplier of £47bn of the wrong sort of submarines to Australia. At that point, France had only gone so far as cancelling a joint Franco-US drinks party to celebrate two centuries of détente. Recalling its Ambassadors from Canberra and Washington (and insulting the UK by not bothering with London: “fifth wheel on America’s wagon”), President Macron having upped the ante in notably undiplomatic language then threatened the nuclear option. He publicly announced that he was considering giving up France’s permanent seat on the UN Security Council to Brussels to allow the development of a new, separate EU defence force.

 

It is undoubtedly true that France and its defence industry have suffered a national humiliation, for which President Biden and Boris’s exclamations of disbelief at Macron’s extreme reaction are either utterly disingenuous or reveal stunning naivety (the former, undoubtedly: in the same position they would have done precisely the same). But there is a level of confection in Macron’s rage: he is up for re-election next May, he is on the back foot in the face of a resurgent centre-right Republican Party as well as still facing down the constant caucus-splitting threat from Marine le Pen’s nationalists; invoking the cast-iron political law of “never let a good crisis go to waste”, there’s nothing like dishing out a good kicking to perfidious Albion to unite the French; he would have looked a dupe and a donkey had he not done so.

 

There are many intertwining strands to this story, not least France’s enduring enmity towards the UK over Brexit and its determination to perpetuate persecution (just this year fisheries disputes and threatening to suspend electricity supplies to Jersey; actively undermining AstraZeneca’s Covid vaccine; the failure to implement agreed anti-migrant measures in the Channel; Macron leading the defence of the Northern Ireland Protocol enforcement etc etc). But, make no mistake, this is potentially a seminal moment for the West in its stand-off against those nations who could do it harm: China, Russia, Iran, North Korea, the usual suspects.

Uneasy NATO relations

France has always had a somewhat flaky relationship with its NATO allies. A founder member in 1949, President de Gaulle demanded in 1966 that all military commands on French soil but not directly under French control should be closed, including NATO commands to which France itself was contributing (it is often misunderstood that France did not in fact leave the alliance: technically it remained a member, on call in the event of Article 5, though NATO took steps subsequently to remove French military personnel from all its commands and head-quarters wherever they were located, whether on French territory or not).

 

France was readmitted as a full participating member in 2009 (France has not been invited to join AUKUS subsequent to this row because Biden and Boris know that Macron’s first interest is France and his second is that of the EU, and the EU’s attitude to China is very different from America’s and ours). However, since the fall of the Berlin Wall and the collapse of the Soviet Union in 1990/1, and with western European governments’ demands for the Peace Dividend (i.e. significantly reduced commitment to defence expenditure and greater and greater reliance on the US to foot the bills) and growing public antipathy towards America which, nominally, was still officially an occupying power in both West Germany and West Berlin before reunification, tensions in the Alliance have been palpable. The list of countries among the 30 members which meet the minimum 2% of GDP defence expenditure criterion is depressingly short (and even then, some which do including the UK only get there by smoke-and-mirrors accounting), culminating in Trump memorably and publicly reading the riot act to delinquent government heads in no uncertain terms. Trump’s hawkish stance with his junior allies was further and understandably exacerbated by Germany, with its significant trade surplus with the US, mortgaging its economy to Russia with the Nord Stream 2 Pipeline. Trump’s argument with Berlin could be succinctly summarised as “we’re not only paying for your defence but also supplying the kit and manpower; you’ve hitched yourself to the enemy for the bulk of your energy supply; and in the meantime, you’re eating our lunch”.

 

It was not lost on Beijing and Moscow in particular that come the clarion call to arms in the Balkans in the 1990s, or the Gulf wars and when Article 5 was invoked immediately following 9/11, just how few NATO members beyond the UK and the US were active and willing participants and to what extent; if they actually bothered to turn up at all.

“You can go your own way”. European defence UDI?

One of the hallmarks of the nation state alongside self-determination with taxation through representation, issuing and having control over one’s own currency, having a foreign policy and despatching recognised ambassadors to overseas capitals, is having an accountable defence force and an accompanying defence policy. The EU has been striving on and off with varying degrees of enthusiasm in pursuit of a common defence policy, proposing essentially a pooling of military forces and resources, not least to help spread the cost of procurement for fantastically expensive weapons systems. Only this month, in the aftermath of the Afghan debacle, Ursula von der Leyen at the European Commission (herself a notably ineffective former defence minister in Germany) pitched the idea again. The principal problem is the paucity of existing armed forces, whether in numbers or sophistication, among the EU’s member states with the exceptions of France and Poland, especially since Brexit; Poland’s position is complicated by it being, alongside Hungary, a permanent occupant of the EU’s naughty step, regularly threatened with Article 7 and the suspension of voting rights for its values being incompatible with those of the Union, further the withdrawal of most US and UK forces from Germany has rendered the Warsaw Gap significantly more vulnerable to attack should Russia mobilise westwards.

 

Brussels’ political motivation is to disintermediate the influence of the United States, to prove Europe is equal to the task as a global ‘power’. That aspiration is largely delusional certainly in the foreseeable future. The fact that the US accounts for 72% of all NATO funding, and considerably more in terms of fire-power and military effectiveness illustrates the extent to which Europe is substantially under-resourced both in terms of equipment and expertise with which to defend itself effectively without US help. Indeed, in the case of the EU’s biggest economy, Germany, not only are its armed forces regarded as some of the least effective and most ill-equipped in Europe (some would be as unkind as to describe them as a joke), but it would also require constitutional change to allow them to participate in expeditionary warfare, far from a given in the event of a leftward lurch in government in the post-Merkel era. History tells us that on every occasion when presented with the choice of participating in military conflict, the EU (as distinct from some of its members) has proved completely useless.

Contextual? No! Immediately relevant! Think gas and Evergrande

Does all this matter? Or is it merely mildly interesting to the geopolitically curious but irrelevant to investors. We would argue that in fact, it matters a lot, not only for the longer-term but some is of direct relevance to investors now. For regular readers of these columns, follow the trail and join the dots in the analyses we have written in the past few months about Iran (August), Afghanistan (ditto), China’s new revolution (last week), climate change (August), the G7 Summit (June): a common theme is the extent to which western foreign policy, and particularly US foreign policy under the hapless President Biden, is disjointed (and in Afghanistan proved disastrously dysfunctional), revealing structural and strategic weakness and incoherence. Arguably that is a function of the luxury of living in democracies rather than autocracies, theocracies or dictatorships. Nevertheless, one does not have to be a strategic genius to see that in Beijing, Moscow, Tehran and Pyongyang analysts reading the geopolitical tea leaves can detect a palpable loss of direction in the West, a sense of insecurity, and a significant shift of emphasis by both the US and Europe. The foreign policy schisms are all-too obvious; our foes barely need to sow dissent to create division, we seem quite capable of doing it all by ourselves. We are doing their job for them.

 

In our analysis of Afghanistan, we suggested that the ripples of the western policy failures when NATO was summarily sent packing would be felt as far afield as the Baltic, Ukraine and Taiwan. What we are witnessing today is the likes of Putin, Xi, the Iranian Mullahs and Kim being emboldened to push the boundaries, to take more hawkish and aggressive stances.

 

There are many contributing factors to the current significant spike in global natural gas prices which inevitably will feed through into the inflation numbers, but one of the most significant is Russia deliberately withholding supplies, both in its own interests of profit, but also actively flexing its muscles to demonstrate that it can effectively hold countries to ransom at the turn of a tap. Ukraine is particularly sensitive because of its almost total reliance on Russia for its gas energy supplies (it is a widely held view in that country that Putin will try and freeze Ukraine into submission this winter); it should be a significant warning to Germany.

 

In China, with the West powerless or disinclined to react to the illegal annexation of Hong Kong, the public rhetoric at the 2021 centenary celebrations of the founding of the Chinese Communist Party was deliberately nationalistic: Taiwan and Macau are expected to re-join the Motherland the implication being by force if necessary, if anyone objects with hard power then force will explicitly be met with force. But further, it emboldens Xi to tighten his grip domestically, to prosecute his revolution of the re-socialisation of Chinese society with policies one direct manifestation of which is the corporate collapse of Evergrande, the property developer, which has sent ripples around world securities markets. In Korea, it is no coincidence that after a two-year break Kim Jong-un last week sent his test cruise and ballistic missiles winging towards Japan again, the whole of which country is now within range of such technology should North Korea succeed in developing a nuclear capability however crude. And in Iran, again a developing nuclear power in a strategically highly sensitive location, Tehran has the US in an embarrassing vice in America’s negotiations to be re-admitted to the Iranian Nuclear Containment Treaty. So yes, these things are relevant however distant they might appear.

Central Banks: girding their loins for the next step

Both the US Federal Reserve and the Bank of England policy committees met this week. With one further kick of the can down the road, the Fed intends in November to announce whether it will begin slowing the pace of liquidity injections in its quantitative easing (QE) programme. Stopping QE entirely needs to be a pre-condition of being able to raise interest rates at a later date, quite possibly in 2022 rather than delaying to 2023. This is a linear process, nevertheless this latest announcement strikes a more immediate sense of urgency than hitherto.

 

Meanwhile here, the Bank of England’s tone was also more hawkish, pointing to a modest tightening in policy “over the next few years”. The economic backdrop is confused: near-term inflationary forces are at work, not least most obviously in labour and energy markets as economies recover, albeit with increasing frictional pressures from dislocated supply chains and employment shortages potentially constraining momentum. On the other hand, the knock-on effect of the Chinese credit constraint to contain burgeoning property prices risks a significant slow-down in the Chinese economy potentially spreading further afield into the wider global economy this year and into the beginning of 2022 (in a ‘normal’ year, such is the effect of China as the swing producer and consumer in the world’s economic system, China contributes a third of incremental global growth on its own). Having already seen Sweden, New Zealand and Canada’s central banks trimming their balance sheets, it was notable this week that Norges Bank, the central bank of Norway, became the first developed market bank to raise interest rates in this recovery phase. The combination of all these factors has led to a broad 0.1 percentage point rise in government bond yields as investors react to the increasing likelihood of major central banks taking positive action rather than merely talking about it.

 

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.

The value of active minds – independent thinking:

A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.

Fund specific risks:

The NURS Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request. The Jupiter Merlin Conservative Portfolio can invest more than 35% of its value in securities issued or guaranteed by an EEA state. The Jupiter Merlin Income, Jupiter Merlin Balanced and Jupiter Merlin Conservative Portfolios’ expenses are charged to capital, which can reduce the potential for capital growth.

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