The Fat Tail: The Power of Political Knowledge for Strategic Investing

April 7, 2009


JOANNE MYERS: Good morning. I'm Joanne Myers, Director of Public Affairs Programs. On behalf of the Carnegie Council, I'd like to thank you for joining us.

Our guest this morning is Ian Bremmer, and his book is The Fat Tail: The Power of Political Knowledge for Strategic Investing.

As anyone with a stock portfolio knows, it has been a rough time for the markets. With many portfolios down, the large loss of equity and wealth has been very difficult on individuals, corporations, and, yes, even foundations. The problems, of course, have not been confined to the United States alone. This economic crisis is a global event that is also having a severe impact on economies in Europe, Asia, and the developing world. With job layoffs and bankruptcies, business is tough all over. In fact, fears that global economic unrest will lead to political instability are widespread, especially in countries such as Russia and China.

For the most part, investors have always been aware of the unexpected and undeterminable, but to recognize that, in the international economy, politics matter as much as economics is a relatively new concept. Still, having the right tools to read the warning signs, to analyze investment climates, and to manage the changing economic circumstances in order to predict the risks was rather limited—that is, until Ian founded the Eurasia Group and wrote, with his coauthor Preston Keat, a primer on how to anticipate and assess the unexpected.

The title of the book, The Fat Tail: The Power of Political Knowledge for Strategic Investing, refers to scenarios that seem improbable, unlikely to happen, and difficult to predict. But when these events do occur, they will have high impact and could have catastrophic effects. On a risk-distribution curve, this is referred to as a fat tail, and fat tails are what cause the downfall of fat cats.

Our speaker argues that extreme events, especially extreme adverse events, happen much more often than they are supposed to in the world of classical statistics.

While difficult to quantify, on a fundamental level, they are no different than any other form of risk, if you have the know-how to interpret the data. In Fat Tail, Ian and his coauthor connect the dots between political disaster and economic turmoil, and in so doing, posit new ways to analyze and prepare for doomsday scenarios.

Leaving nothing to chance, they demonstrate with poignant examples how planning for such political developments may produce changes in economic outcomes that can either make or break a company.

As master of the growing art of political risk, this isn't the first time that Ian has made a growing contribution to our understanding of the business world. As his résumé will indicate, this young prodigy has traveled the world, lecturing, writing, and observing the rise and fall of markets.

Political risk analysis employs the art of innovative thinking. Accordingly, in reading Fat Tail, you will find useful insights that not only help private investors like yourselves, but you will discover why our speaker is so instrumental in assisting decision makers in finding the answers to questions they may have, while also providing the answers to the questions they may not know they have. After reading this book, you will come away knowing why Ian is always ahead of the curve.

It is always a pleasure to welcome Ian to the Carnegie Council, and today is no exception. Please join me in giving a big round of applause to our speaker today, Ian Bremmer.


IAN BREMMER: Thank you, Joanne. That was very, very gracious, very kind. I had better milk this prodigy thing for as much as I can, because my 40th is coming up in a few months. It's just not going to work for long.

First of all, thank you. This is a wonderful audience for this morning. I would like to think it was about me, but I know about the programs that Joel and Joanne have been putting on and the increasing popularity of these fora. It's wonderful to see. I am very proud to be affiliated with this august organization and with my good friends here, Joanne and Joel. So it's a real pleasure.

I remember when I was first talking about this book coming in and Joel said, "We want to throw you an event. You have to promise. We're going to set it up now." I think we set this up six months ago. It was the first thing we did, to say we were going to come to the Carnegie.

I want to talk about fat tails. Joanne explained the way I think about them. In the book everyone knows that fat tails hit us nowadays. They know these one-in-100-year storms that increasingly seem to be coming along roughly every 15 minutes.

My point is not that they are there; my point is that, increasingly, it's politics that is driving them. That's new. It has been around before. It was around in the 1930s. We can say it was around during World War II. But we haven't seen an environment since then where politics was such a fundamental driver for market outcomes.

When I started Eurasia Group back in 1998, our focus was on emerging markets, those countries where, I would argue, politics matters at least as much as economics to market outcomes. In today's environment, political risk is not just about emerging markets. At the beginning of every year, we write about the top risks as we see them going forward for the coming 12 months.

Iran, of course, was there, and Pakistan, of course, and Afghanistan were there, Russia was there. But number one was Congress. Number one was the likelihood that we would see significant market impact from decisions that were being made in Washington, D.C.—as I would call it, the new capital of capital. It used to be New York. It's not anymore. And that is, of course, happening all over the world.

So I want to talk about that. I want to talk about how the world is changing in that regard.

I was in London last week with the G-20 meetings. I had a lot of meetings with delegations while I was there. I thought you might want to hear just a couple of minutes, since it has been in the headlines, about my view of the G-20 and my view of how that all went.

Clearly, first of all, the demonstrations were vastly overstated by the media. Two of the demonstrations that I saw had—and I'm not exaggerating—roughly pari passu between photographers and anarchists. Great media opportunity, there's no question. There wasn't a lot of violence, thankfully. The city was pretty locked down. The British police did a great job.

Also Obama: the extraordinary, extraordinary support and sentiment that Obama has internationally is something we should not lack appreciation for. A year ago, if you had said the next president of the United States will be greeted with such hope and such open arms from the entire political spectrum throughout Europe, and even by someone like President Medvedev of Russia, I would have said, "You're crazy. That's clearly not going to happen." But it did happen. I saw that enthusiasm with everyone I spoke to on the ground in London.

Let me be clear. I don't think that gets him or America or the world as much as we might expect. The vast majority of challenges facing the United States, from a global foreign-policy perspective, were not created by Bush. Iraq was, though now that's on a better trajectory. Most of them are structural, and Obama will not be able to fix most of them, accordingly, even with this extraordinary international capital.

I'll give you three quick examples from the last week.

Number one, Obama goes out to France and talks in historic manner about the importance and the support of the United States for Turkey joining the European Union.

And Sarkozy doesn't hesitate, doesn't equivocate, says France will not support that position. So a lot of political capital; not necessarily a lot of support for that position.

The single most important priority, of course, that Obama has had from a foreign-policy perspective has been Afghanistan. He would like it to be Pakistan, too. The Obama Administration does recognize ground truth on the ground in Pakistan.

In other words, they recognize that the situation is getting close to parlous, that they don't have any control over the federally administered tribal areas or the North-West Frontier Province. They are effectively stateless areas at this point. But they also recognize that they can't do very much about it, so they are going to treat it as a structural long-term problem, and not one that they can respond to tactically.

But on Afghanistan, that was a significant part of President Obama's speaking points with every major bilateral he had with America's allies, and even some that weren't allies. Yet he came away with virtually no support for additional presence on the ground in Afghanistan.

This weekend the North Koreans launched a satellite that was on a ballistic missile. The media got this wrong, by the way. The media is talking about the fact that the launch failed. The satellite failed. The ballistic missile succeeded.

That, by the way, was the North Korean intention. The only reason you put a satellite on top of it is because that way you can say, "We weren't launching a ballistic missile, so it's not actually illegal under the confines of the Security Council and the rest."

But Obama's position was very clear: This is a direct breach of international law. We must call an emergency meeting of the Security Council. They did. They demanded an additional resolution against the North Koreans. There was no equivocation. There was no significant debate. The Russians and the Chinese said no.

So let's be clear. Obama is immensely popular around the world. The ability of the United States to create collective leadership in this environment is very limited. It is perhaps even more limited than it was at the beginning of the Bush Administration, and it has nothing to do with Obama's efficacy as president. It's structural.

One more point, to just talk about the G-20 itself. One of the vice-ministers I talked to who was there made it very clear that you get to the G-20 meetings, you are talking about these major thematic issues, and with translations and all the rest, if you get to make one statement on a major issue, you're lucky. Clearly, everything at the G-20 that is going to be agreed to needs to be basically baked in before the meetings.

This isn't Bretton Woods, where you have three weeks of folks locked away, without a lot of media. This is one day, half of which is preplanned speeches. There is not a lot of "there" at the G-20 itself—a lot of meetings on the sidelines, very interesting, very important. The G-20 itself is not going to get much done, except for the fact that all of those heads of state have domestic constituencies that they need to speak for.

So the situation you end up in is that, in advance of the G-20, a slew of information about what you think is going to pass has already been leaked out. There is not much likelihood that you get much more than that, but there is a non-negligible possibility that statements by some of the leaders to their own domestic constituencies when they do their press conferences, like we saw from Sarkozy and Merkel at the beginning of the week, can actually derail the process. That looked like a possibility the first couple of days. It got reined back in. As a consequence, a successful meeting.

I firmly believe that the expansion of IMF support is significant. I think that it will help to ensure that some emerging markets over the course of the next 12 or 18 months that otherwise would have fallen off a cliff have a better shot at staying emerging markets. Turkey is a big one here, maybe Ukraine. There are a few others. I'll talk about that when we start talking about the fat tails that I'm expecting we will see going forward. But that was a big deal.

On the trade credit expansion, I don't know. The Japanese that I spoke with said that they did it because the Europeans asked them to, but they didn't see any point for it.

The regulatory commitments made on free trade and no protectionism: The Brits said they were out there, because they were asked to, but they also see that 17 of the G-20 countries, since December, have passed about 45 protectionist measures on trade. Nice to make the commitment, but the actual facts on the ground over the next few months are going to be a little different.

I think the G-20 was a success in adding value to a lowest-common-denominator approach. I think it's a kludge, but I think it was a strong kludge. It's probably the best you can hope for.

What the G-20 was not last week was the beginning of the creation of new financial architecture. It was not the beginning of coordination of global financial stimulus or regulatory policy. It was not that, it could not be that, and it will not, in my view, become that. In fact, some of the big issues that are becoming serious points of debate between, for example, the United States and China over how financial architecture should be run in the long term; they fundamentally don't agree.

One of the other really interesting things that came out of the G-20—and then I want to move to the structural changes that we are seeing in the world today—is that the delegations that were there, the media, the entire G-20 basically saw the United States-China meetings on the sidelines as the G-2.

That's interesting. It shows that there is, first of all, a fear of this vacuum of leadership, but also a general willingness to accept—not necessarily to like, but to accept—the fact that China is kind of a superpower on a standing with the United States. We are moving in that direction very quickly, except for the fact that China's capacity or willingness to actually play that role is not there. That is a disconnect. It's a disconnect that we are going to see more of.

So those are a few of my impressionistic views of the G-20 from last week.

In terms of why politics are increasingly driving fat tails, two basic issues out there, two ways I see the world increasingly moving. Over the last 20 years, one thing we needed to pay attention to if we wanted to understand how markets were going to move and what the risks were was globalization: multinational corporations becoming the single most important economic actors out there and taking advantage of global economies of scale.

To the extent that that globalization became unfettered and unregulated—what you would call "hypercapitalism"—there were significant inefficiencies. Those inefficiencies did not come because people forgot about profit. Multinational corporations and financial institutions, as a matter of course, in their very essence, seek to maximize profit. But in the absence of any regulation, in the presence of extraordinary leverage, they tend to maximize short-term profit and short-term compensation at the expense of long-term.

We are no longer in a world that is being driven primarily by globalization. We are now in a world that's being driven by state capitalism. Increasingly the most powerful economic actors in the world are the governments, are the states. They are different types of states. They have different types of views of how long they should be in the economy, how transparent they should be about it, what exactly their long-term role should be. But that is a shift.

This shift has been coming for a long time, even while globalization was becoming more ascendant. It started 30 years ago, 35 years ago, with the creation of OPEC, the oil shock, and the ascendance of national oil corporations.

Then, over the last 20 years, the rise of the BRICs, the rise of emerging markets, and with it, the rise of state-owned enterprises and privately owned national champions connected to those governments.

Then, five years ago, the rise of sovereign wealth funds on the institutional investor side. Sovereign wealth funds have been with us for decades, but there was no term "sovereign wealth fund" until five years ago, because of their increasing importance in the global economy at that point.

Then, six months ago, in my view, was the tipping point. Six months ago, when globalization was increasingly not on the rise, but was increasingly being challenged by state capitalism. That was, of course, when Lehman Brothers went bankrupt, because the beginnings of the global recession led to this extraordinary rise of these new capitals of capital around the world, whether it is Abu Dhabi instead of Dubai, or Beijing instead of Shanghai, or Washington instead of New York, where stimulus, regulatory policy, and bailouts meant that winners and losers were going to be determined by government actors.

So over the last 20 or 30 years, we are very familiar with European farmers that aren't productive but are getting bailed out in Europe because they have political influence. So you have mountains of butter and lakes of milk that are not particularly consumed or necessary. We have all pointed that out as potential waste. But it was good for the farmers. In the United States we are going to see mountains of SUVs. We are going to see lakes of ethanol.

I'm not suggesting that this is more or less of a problem. It depends on whether or not you benefit from those subsidies, or lack thereof. But the real point is, you had better understand what Washington is doing, because they are the ones that are going to determine who the winners and losers are.

When Obama came out last month and said that we in the United States are facing economic catastrophe if we do not get the stimulus right, as a political scientist, I read the flip side of that: It doesn't matter what the banks do. It doesn't matter what the plans are that come from the automotive companies. It does not matter how many additional hundreds of thousands of people are laid off or not by different companies in different sectors.

If Washington doesn't get it right, we have serious trouble. So your risk factors are not Wall Street; they are surely not Main Street. They are K Street. And that's what we need to pay attention to.

This, of course, is happening in other countries as well. It's happening in the Emirates. If we used to want to make money in the Emirates, we went to Dubai, because that's where they build those really tall buildings, so there must be lots of money there. That was true until it wasn't, over the last six months, and then Abu Dhabi just came about a month ago with their first tranche or bailout of $10 billion. There will be more.

But if you are running a sovereign wealth fund in Abu Dhabi, Mubadala [Development Company] or ADIA [Abu Dhabi Investment Authority], it used to be that you had Western portfolio managers who had lots of cash and they were looking to see how they could maximize their portfolio. When you have huge amounts of cash, you don't care what your priorities are because you can do all of them. Just throw cash at them.

But in an environment where Dubai is potentially collapsing and where liquidity is under constraint, suddenly politics matter a lot more.

We are seeing that these Western portfolio managers in these sovereign wealth funds have been sidelined or fired and, instead, they are looking at political needs first and foremost, which means that if you are Mubadala or ADIA, the first thing you are doing is bailing out Dubai.

The second thing you are doing is ensuring the stability and the sanctity of the UAE, the Emirates. The third thing you are doing is looking at the Gulf Cooperation Council, and making sure your relations in your region are okay. Then you can think about other profitable activities you might engage in.

It's not that they don't want to make a profit. But profit in Dubai will not be the primary consideration as to the $10 billion that is made available to these guys. And there will be more.

In China, the same decision process, as they try to stimulate Chinese consumption, as they try to build Chinese infrastructure, as they try to ensure a Chinese safety net, as they try to work their way up the value chain with increased technology and exports. All of those decisions will have a medium to long-term negative impact on the U.S. dollar.

If you are, say, sitting in Tokyo running Nomura and you are thinking about your currency allocations, and you see what's happening in Abu Dhabi and Beijing and the rest, and you hear the Chinese government talking about the need for an alternative competitive reserve currency over the long term, that affects your currency holdings as well. It has this knock-on multiplier effect.

So long term, the move from globalization to state capitalism is something I think we need to pay a lot of attention. That's the first big change.

The second big change I see is the geopolitical. This comes back to Obama's extraordinary international capital and yet the fact that so far he hasn't seemed to make many inroads on some of these big national security challenges that face the United States.

As the world moves away from a U.S.-led unipolar system, where the Americans were doing a majority of the lifting, we are not moving to a multipolar system. A lot of people say we are—for example, the Chinese premier and the Russian president, my dear friend Kishore Mahbubani, the former ambassador here in Singapore, and Fareed Zakaria, also a very good friend.

A lot of people talk about the rise of multipolarity, different countries becoming increasingly important around the world. There's no question that there is a "rise of the rest." Other countries are becoming more important. But I don't think that means we are moving towards multipolarity.

Multipolarity, for me, is a system where various countries have different ideas about the way the world should be run. They are sometimes competing and they are sometimes complementary.

The world I see us moving towards is one where there is increasingly an absence of leadership, an abdication of leadership on the global stage, where a country like Russia has an enormous amount of interest in how Russia is run.

They have a very strong interest in how their neighbors' countries are run. Sometimes that's conflictual with those neighbors, like in Georgia or Ukraine or with Norway over the North Pole. But there is a general abdication in Russia of interest in how Latin America is run or how Africa is run or how climate change should be managed or how nonproliferation should be dealt with or how collective security in Iraq or Afghanistan should proceed.

I use Russia because it's an obvious example. The Europeans express much more interest in how these things should be done internationally, but in reality their ability and willingness to act is more constrained—and so, by the way, is that of the United States, where a majority of Americans increasingly don't support free trade. They used to. Over time, this is going to create a challenge.

Here's the most important point that I can make around these political fat tails: If you buy this, if you agree with me that we are moving towards a system of state capitalism and a system of non-polarity, the most important takeaway is that those systems are not in equilibrium. They are not sustainable. They don't deal well with global challenges and shocks. In fact, they create their own endogenous shocks. Let me give you one example that I think will make this make sense.

If you look at the nonproliferation regime, I don't believe there is a single person in this room who would disagree with me when I say the nonproliferation regime is broken and that, furthermore, that is a worrisome thing in terms of humanity, in terms of global economic development, all these things.

The North Koreans said they wanted a nuke. The U.S. said, don't test or we'll get angry. They tested. Americans got angry. But nothing happened, because nothing could happen. Now the North Koreans have about eight nukes.

The Americans are buying them off, with the Chinese, and it's more or less stable—until, of course, the North Koreans sell some nuclear technology, just like they sell ballistic-missile technology and engage in human trafficking and engage in drug trafficking, because they have historically sold anything they get their hands on.

That should worry us. Iran is now moving towards nukes. I'm not suggesting that they are going to test. In fact, there are good reasons that they probably won't test a nuclear weapon as they get closer to developing one. But they are clearly moving towards having the capacity.

Unless the Israelis engage in strikes, Iran will have nuclear capacity, too. It's more likely than the markets think, but it's not likely. Even with the Netanyahu government, it's not likely. It's not 50 percent. It's a fat tail. It's a nice 20 percent or something like that.

This proliferation regime will not prevent new states from going nuclear. It will have a deleterious effect on the capacity of rogue organizations and others to get their hands on nuclear technology.

That is, I would argue, a direct reflection of a system that is increasingly non-polar. Is it possible that that would change? Is there a scenario out there that would make me more optimistic that we would be able to do something and create collective leadership on nonproliferation? Yes, there is: a big shock. I can give you some.

Imagine a situation where Hezbollah gets their hands on some nuclear technology from the Iranians. They have ballistic missiles now that can hit Tel Aviv, the Egyptians tell us. So they put a dirty bomb on top of one of those. They actually hit Tel Aviv. It doesn't kill many people but creates mass panic, overwhelms the public-health system in Israel, and a piece of Tel Aviv is considered unlivable. Sixty percent of Israeli Jews are there. The economy collapses and we have widespread war in the Middle East.

If that were to happen, I'm willing to guarantee you that the Germans will threaten complete sanctions against the Iranians unless they let inspectors in. The Chinese will tell the North Koreans, "We're going to start boarding all of your ships to ensure you're not actually getting anything out."

Now, the good news is that the likelihood of that scenario is pretty darned small. It's not a fat tail. It's more thinkable than it was a year ago. It will probably be more thinkable in five years. But it's not a likelihood.

The bad news is, unless something like that happens, we are not going to see the nonproliferation regime fixed, in my strong view. I can give you analogous arguments for collective security in Afghanistan and Iraq and for climate change and for the global financial architecture.

Here's the rub: Rahm Emanuel came out and said this financial crisis is too great an opportunity to be missed in the United States. Au contraire, it is insufficiently large to be taken advantage of by the United States, because the Republicans and Democrats in Congress are still engaging in politics as usual.

We saw that with the fight over the TARP. We saw that with the fact that we didn't get any political appointees under Geithner for two months. We saw with the fight over AIG bonuses, the indignation that's being expressed by the media.

There is too much comfort in the United States. There is entirely too much comfort for Americans, as a political system, to treat this crisis as sufficiently severe to truly take advantage of it. I'm not blaming Obama. This is structural. It's not a partisan argument. But we need to recognize that.

With that as the baseline understanding of how I consider politics to increasingly cause the fat tails that we are seeing, let me leave you, before we open to questions, with where I think the big fat tails are over the next 12 to 18 months. I say 12 to 18 months because, frankly, those five- and ten-year scenarios that all the planners used to do we can increasingly throw out the window.

Demographic trends, military trends, things that really take a long time and are baked in, sure. But with the political and economic realities of the world, we can really not do useful five- and ten-year scenarios right now. The potential variance in the near term is too great.

The 18-month scenarios are more important than they have been at any time since I have been a political scientist, but we must recognize that the potential discontinuities, the breadth of the 18-month scenarios, are vastly greater than they used to be.

Here are three types of political risks of major fat tails out there over the next 18 months:

The first I already talked about, the new capitals of capital. That's why Congress was the number-one risk. The inefficiencies that can be created by political leaders determining allocations of capital and bailout around the world will be what determines who the relative winners and losers are going to be over the next 12 to 18 months.

That is not necessarily a normal state of affairs for the next ten years in countries like the United States, though there is a bigger risk of that than there used to be. It is in countries like China, Russia, and the Gulf. That's the first fat tail.

The second major fat tail is plain vanilla geopolitical risks: the possibility that there is a war over Iran, or the Pakistan-Afghanistan situation.

We have been dealing with geopolitical risks for a long time. That's what my firm does. But if you look at the political landscape in the world today, over the next year, and compare it to the last year, most of the geopolitical risks are actually more troublesome going forward.

When you look at Pakistan and Afghanistan, clearly they are going to be worse at the end of 2009 than at the end of 2008. If you look at Mexico, where the narco cartels have declared open war against Calderón and the state of Mexico, it's clearly going to be worse at the end of 2009 than at the end of 2008. If you look at the Iran-Israel situation and Lebanon, as a knock-on effect, clearly the likelihood of armed conflict in some variant there is much higher in 2009 than the end of 2008.

Iraq is the one, ironically, that is actually getting better.

The interesting thing is not just that these geopolitical risks are out there. It's that we are not paying attention to them. When oil was $147 a barrel, there was a premium on the price of a barrel of oil from geopolitical risk. If you asked your clients, talked to my guys that were trading commodities, they would all say, yes, $10, $15, $20. When oil is at $45, $48, $50, there is no risk premium from Iran on a barrel of oil. So if that risk hits, it is going to have to have a more jarring effect on the markets.

Also the bandwidth and the ability of international players to respond and react effectively, given the overwhelming focus on domestic economic crisis, is going to be more limited. So we need to recognize that as we think about these geopolitical fat tails going forward over the next 12 or 18 months.

The third is that the scale and the severity and the suddenness of this financial shock create significant social instability in emerging markets and frontier markets, places particularly where you have a middle class that had rising expectations and lives in urban areas and suddenly is not getting what they thought they were going to get.

The interesting and important point here is that that social instability is not a leading indicator. It is a lagging indicator. Usually, historically, it takes 12 to 18 months for a major economic crisis to flow through emerging markets before you start to see that kind of social dissent, which means we have not seen it yet. But it's coming.

So the United States markets may be a leading indicator and, conceivably, some economists think you might actually have already gotten through the worst of what the markets were going to experience. Believe me, I'm not calling bottom. I don't do stuff like that. But some people now are, and in the next three or six months, increasingly people will. We will not do that on emerging markets. On emerging markets, the unemployment and the lack of social benefits and the instability will create threats of social revolution, coups, regime change, more radicalism in a host of different emerging markets.

That's why the IMF expansion, from my perspective, is the most important that came out of the G-20. Even if it's inefficient, even if it's poorly allocated, even if it's a kludge, it will work better than the alternative.

Which countries am I thinking about in particular that are least likely to be resilient in this environment? Argentina, Venezuela, Nigeria, Egypt, Turkey, Ukraine. Russia is the big one, maybe Thailand. Russia is the one I'm most concerned about. I do not believe there is any real likelihood of a 1930 scenario coming, short of a 1920s-1930s-type economic hit. The economists aren't predicting that, so I wouldn't predict that level of political instability.

I wouldn't predict that kind of war, because at the end of the day, the Americans and the Chinese need each other. They may not like it, the Chinese in particular. They don't want to be economically coupled, so the Chinese are increasingly politically decoupling, so the Chinese people will blame the West for this crisis and the downturn, which they are doing very effectively, from a domestic perspective. But economically they understand that they are coupled.

As a consequence, the likelihood that you will see nuclear protectionism—really virulent protectionism that takes trade off a cliff—that we are very unlikely to see. I don't think it's likely we are going to return to a 1930s-type environment, with the exception of, potentially, Russia. That's one fat tail. The reason for that is that, really, there are very few institutional constraints on Putin. His ability to move the country in very different directions is high. We don't have a lot of transparency over that. The potential of very significant social discontent is high. It's not likely to be tolerated in Russia, and he has not had to experience any of it since he has come in, because 1998 was when they had their crisis. Since then it has been all peaches and cream.

There must be a good Russian analogy for that—"osleefki" (phonetic) and something, sour cherries, that shows the nature of the Russian soul.

I am a little worried about that. But otherwise it's a lot of these other emerging markets that I think we could really be watching out for, and we will see serious strains there.

To end with some good news, there are a lot of places that I consider to be much more resilient in this environment: Number one, China. Everyone has been talking about the fact that if China has less than 8 percent growth, then things are going to go to hell. I have no idea who did that math. I have seen it in the Financial Times and the Wall Street Journal. It's just wrong.

Over the last 30 years, the Chinese have actually grown, on average, 10 percent a year, because of the Chinese government. The average Chinese sees that. They see the way the Chinese leaders are treated at Davos and at the G-20 and by Obama. They see the way they are treated by the U.S. government when Hillary Clinton goes over, a couple of months ago. They see what happened with the Beijing Olympics. There was an enormous amount of support for Beijing among the average Chinese.

Now, there are things they are upset about. They are upset about shoddy construction of Chinese houses and the schools in earthquake zones. They are upset about poison in their powdered milk for their infants. But they do not blame the Chinese government, as I suggested, for this downturn. They blame the West.

The danger, of course, is that just because unfettered hypercapitalism in the West proved to be an excessive and not efficient system, that does not mean that utter lack of rule of law and corporate governance and transparency is a winner system in China. Yet that is the lesson that will be taken. That will prove problematic for Western corporations that are investing in China over the medium term.

That's a risk, but not Chinese growth. Chinese growth and stability over the next 18 months looks very solid to me, likely to exceed what the markets think.

I'm very excited about the Gulf, Saudi Arabia, Qatar, Kuwait, Bahrain, where there is a lot of stability and a willingness to use this crisis, as Rahm Emanuel suggests, to actually put reforms in place that will make them more stable over the long term. They recognize the severity of the crisis. There is a lot of consolidation of power, and they have some resources to do it.

Brazil: Over 80 percent approval for Lula, a political consolidation of the whole spectrum around him in the center. It's going to lead to, I think, a very smooth eventual succession and transition, once Lula is gone. Also, given the alternative energy capacity, as well as the offshore oil finds there, I'm very, very excited about Brazil. I think they will do quite well.

Then India, which is the slowest-moving good story in the world. But decentralization of political power, which makes it difficult to grow infrastructure, also gives them a lot of resilience when you have serious social instability coming from a downturn. I actually think that system will prove itself to be quite resilient.

So there are some good stories in this environment.

A final point. Long-term, there is a good story in the United States as well—long-term, not short- to medium-term. One of the good things about being able to screw up in a country like the United States is that you get to do it again and again, where in an emerging market, if you make big mistakes, you can actually go off the path fairly quickly. That's, of course, one of the reasons why the big fixes don't get made. But there are some things that make you more optimistic about the United States long-term.

First, of course, is demographics, the fact that the United States does have the ability, through its population growth—in a way the Europeans certainly don't and aren't going to, and as the Turks never get in and as they have anti-immigration policies. Some of that is young, while some of that is aging. But that clearly helps to get rid of the overhang over the long term and build more productivity.

The second is, as oil is replaced with something, the fact that the United States still has scale as an economy and still has the world's best graduate institutions and does have transparency and effective rule of law means that it's a good bet that most of the patents for whatever that new thing is and the wealth is going to be generated in the United States as opposed to someplace else.

It's not as good of a bet as it was five years ago, because you start to see competing centers of academic excellence in other parts of the world—in Singapore and Abu Dhabi and elsewhere. You also start to see, for example, the sea turtle phenomenon: some of the most talented Chinese that were working in the United States are now going back to China. Clearly, the H-1B visa issue around financial institutions that receive TARP funds having to get rid of foreigners before they get rid of Americans is not going to help.

But, still, these are nibbling around the edges compared to the big ingrown advantages.

My third and final point is that if the United States is completely stuffed on all of these soft-power arguments, they still have by far the world's largest military. That includes the only real blue-water navy. Ultimately, if the Chinese want access to commodities in places like Africa and Latin America, they have to deal with that. I'm not talking about war. When NATO invites China to come and they send a frigate to watch, it makes a point.

Piracy is becoming a bigger issue. Guarding the straits is becoming a bigger issue wherever you go, whether it's Hormuz or Malacca. Increasingly, the ability of the Americans to project that kind of power will, at the lowest-common-denominator level, requires a level of greater strategic compromise and cooperation between the United States and other countries than one might otherwise expect, if things get ugly.

That wouldn't be a good scenario, because it means Americans certainly get hurt. But other people get hurt more. So in a relativistic game, if that's what you are playing, you still feel pretty good.

But that's long term. In the short to medium term, there is a lot more pain, I think, in the United States comparatively, and it's not as good an investment, from my perspective, especially on the dollar terms.

Anyway, that's a little bit about the fat tail. I hope it has gotten you up in the morning.

Thank you all very, very much. I'm looking forward to your questions.

Questions and Answers

QUESTION: My question is related to all this discussion we have had about the U.S. dollar really losing its position as the global reserve currency. What do you think about the G-20 decision to allocate this $250 billion through SDRs [Special Drawing Rights]? What's the long-term prospect for the U.S. currency?


IAN BREMMER: First of all, I think we need to recognize that that $250 billion is a commitment. As you and the UNDPwould certainly know, commitments are nice, and then you end up seeing if there is any penalty for noncompliance and what the domestic constituencies actually say about approval and how important it is down the road. I don't think either of us would expect that we ever actually realize that figure.

But it creates confidence, and creating confidence is part of the issue. It shows commitment. Some cash will actually be allocated.

So the first point is, I'm not a huge fan.

Secondly, I think that the issues here, long-term, are going to be overwhelmed structurally by the relative size of the U.S. debt, which has been added to in historic and monumental fashion over the course of the last six months, and we are not done with that. We know they are going to be coming back to Congress for more cash.

Yet with the baseline projections of the Budget Office in Washington, the scale of those deficits would lead to outsized U.S. inflation, even with continuation of Chinese levels of Treasury support. My baseline expectation is that we cannot expect that to continue. Even if the Chinese would want it to, even if they consider it a priority, they are not going to be able to. Other priorities will demand more attention. That's going to happen in other countries as well.

So I think we are on a structural path here.

QUESTION: A quick skim of your book. You cited Kennan's "Mr. X" article as a methodological case. As you alluded, I think Mahbubani and others may be developing something that might be considered sources of American conduct as a way of thinking, which strikes me as something that might influence the fat tails and such.

Is there an American discourse that might talk about sources of American conduct? Is my impression that that might be relatively undeveloped, fair? Is it as important as I might think it is, as I think about the counter that is coming at us, if you will, from the Asian values school of thought?

IAN BREMMER: I would say that you're right, they are underdeveloped in terms of an internal debate in the United States, because no one has had to have that debate. There has been a general presumption that the international system is going to work the way the United States, with the support of its allies, is basically going to function.

Other countries, if they want to be a part of that system—and of course they do, because the benefits will redound to them—will have to get in line and basically move towards those values. We will have the right to criticize them and keep them out and sue them if they do not engage in support of those values, whether we are talking economically or strategically.

That's changing, clearly. But the change is not only coming from the fact that there are countries out there that do not share the same basic values of how the United States would run various types of global issues. It's also coming internally from the fact that the United States increasingly is not sure how much of a world policeman it wants to be.

We just voted for a president in the United States and that is, I believe, the last election we will have for a generation where you can vote for a president and not know or care what their view on China is. That's not going to happen again.

I think we have no appreciation of how important China is going to become in the American political discourse over the next few years. It is going to exponentially grow, and it's going to become challenging. It doesn't mean it has to be conflictual fundamentally, but it's going to be become very challenging, and there will be people all over the political spectrum.

I think the support for isolationism in the United States will be far too serious for serious political candidates to ignore. There will be too much money in it. It doesn't mean they will win, but it means that's going to become a real trope.

So I think the opportunity for that kind of dialogue in the United States is just about past. There is still a little bit of such an opportunity, but it's so overwhelmed by the economic crisis.

Rather than what American sources of conduct should be, you will increasingly have a dialogue about how much of a role the United States should be playing in the world. Should the United States really be swanning off to Turkey or Pakistan when Katrina doesn't get fixed in New Orleans and when folks are losing their jobs in Detroit? I think that's going to become a much more compelling U.S. political debate.

I am, again, not suggesting that that means America moves into a really protectionist spiral, but I think that's the fight they are going to have to have. The sources of American conduct are more of a luxury for the thinking classes. That's great, and there will be people talking about it in Washington and think tanks. But that's as far as it's going to go.

QUESTION: You were talking about the capital capitalism. If you look at the Eastern and Central European countries, where around 80 percent of the GDP is produced by multinational companies, the governments, the capitals, have not had a real influence on the real procedure or the market within the country. So how do you see the capital capitalism in those countries?

IAN BREMMER: First of all, the fact that you have, for example, the Russians coming in now and taking larger pieces in companies in Hungary means that you may see state capitalism, but if those local states aren't sufficiently strong to have their own control of some of these resources, then the captured economies may come at the expense of other countries.

The multinationals don't have liquidity. They are going to have to get it from someplace. The most obvious place is the local government. If the local government can't bail them out, someone else will or they fall apart.

At some level, where the price is sufficiently cheap, other countries will come in, and especially because in countries like the United States, if the Chinese want to come in and buy Wal-Mart—look, they don't really want Wal-Mart to go and do a huge business. They want to own Wal-Mart over the long term. Of course they do. The Americans would like to own all these companies, too, but the Chinese are increasingly developing the capital. In that regard, they are not going to be allowed to.

In a country like Hungary, the ability to stop that and the ability to counter it effectively is much more limited. The Australians are having this conversation in a very big way about the Chinese right now.

But I'm a little more optimistic as well about the long-term developments of the EU. I'm not someone who believes the euro zone falls apart. I'm not someone who believes the Germans pull themselves out, and certainly not the Italians. The importance of bigness of economic space makes it very clear that no one would go into a Italian lira if it was all by itself. That's an unfortunate example because it's the Italian lira. But, still, I think that's where we would be heading. I think the euro zone expands.

I also think that the fact that the Germans have been reluctant to tie themselves to a general EU plan for bailing out East European countries as they fall off a cliff doesn't mean that those countries won't get bailed out. It doesn't at all. It means that the Germans want to decide on a case-by-case basis how to do it, and they want to make the decision from a national perspective as opposed to from an EU perspective.

That's a reasonable perspective. I think that was kind of misreported by some of the pro-strong-integration-euro journalists on the street in London and in the United States, in New York.

But generally, I think being a part of the euro space is extremely important, especially in this sort of a downturn. When I was talking to the Brits around the G-20, they are very, very concerned about the possibility of a Ukrainian default. I'm actually not, because I think the political actors don't gain as much from it, but they are.

But their point was, we have to be very careful about what we do for Ukraine, because anything we do for Ukraine, we must do considerably more for anyone in the EU space. Everyone in the EU feels that way. The EU space matters. That's a serious safety net that a lot of these countries—places like the Baltics—just couldn't do by themselves. So I think it's actually quite important.

QUESTION: The price of a barrel of oil on the balance sheet of medium-sized oil companies around the world is much cheaper than going out and drilling for it in expensive locations.

Why aren't U.S. multinational oil companies, who are sitting on tens of billions of dollars—Exxon, Chevron, et cetera—being more aggressive in buying up medium-sized companies around the world in the natural-resource and petroleum area?

IAN BREMMER: That's a very important question. ExxonMobil is being a little more aggressive than others, because ExxonMobil is centralized.

The answer I'm going to give you is going to be very unsatisfying to you. It has a lot to do with the structure of these oil companies.

ExxonMobil is actually a very centralized company that has all of their decisions of risk management and investment made in Irvine. As a consequence, even though they are quite conservative about where they put the general barrel of oil, they tend to invest about as much in a serious upturn as a downturn. They invest for the long term; they invest more strategically.

In companies like Chevron and Conoco and others, they are very decentralized. Your compensation is determined much more on the basis of individual country lines and business lines. They tend to gear up and gear down when prices look attractive and not. So as a consequence, they invest a lot in boom times and they invest very little in bear times, and it doesn't make as much sense, long-term, for the effectiveness of the company. But that means that when prices of oil are down, they get their clocks cleaned, even though they are more aggressive when prices are up.

That's one reason.

The second reason, of course, is that unlike Chinese national oil corporations, these companies have shareholders. Ultimately, they really have to focus on profitability as a driver. The Chinese don't.

It would be shocking to me, given everything I just said, if the Chinese had the same levels of risk tolerance around investments as the multinational oil corporations, because the Chinese look at profitability and sustainability long-term. They should be paying a premium for the treatment of oil as a strategic commodity. They do.

As a consequence, even ExxonMobil is no longer an exploration and production company. What they really are is the world's largest refining company. They are very good at it. They are very efficient. But if you talk about a lot of these relatively unstable countries in the world, that oil is getting locked up by national oil corporations in those countries and by those that are more strategic for consumer countries. That's going to continue to change.

One reaction you might see of that in the United States is an increasing desire over time, if oil really gets crunchy—if you see $200 or $300 a barrel—you could have arguments that the United States needs to actually go in to some of these companies, create a national oil corporation, and say that's the only way you are going to be able to compete. The Japanese have done it with JOGMEG. Boy, is that going to be a serious debate in the United States.

Now, of course, ExxonMobil and other oil companies are quite flush right now. But over time you could imagine that environment.

QUESTION: I was wondering what your thoughts are on the 12-to-18-month outlooks for South American countries. You talked about the increased role of states. With the unique ideological and political forces right now in a lot of those South American states, I was wondering what you think will happen.

IAN BREMMER: When we talk about unique ideological forces in these states and populist forces, I think we are talking mostly about Venezuela and Bolivia. Let's leave aside Cuba, which is small and not very important.

In the case of Venezuela, I think Chávez is in a great deal of trouble. We were just talking about oil. Venezuela actually runs at a deficit when oil is at less than $85 to $90 a barrel. That's a disaster. They just don't have the ability to continue to spend the way they have.

Chávez just skated through with support on this most recent referendum. He used the state-owned media very well. He turned on the populist charm, and the opposition proved completely incompetent.

But he almost lost it. And if he had lost it, there would have been violence. That was a near-miss for Venezuela, I think, because he could have gone authoritarian. This guy would not have gone down easily.

That game's not over. Unless oil prices turn around significantly in the next six to 12 months, I think Venezuela is in a great deal of trouble, especially because Venezuela is not going to open up to the oil companies internationally now that they are under this trouble.

I had this debate recently. Tom Friedman believes that when oil prices go down, petro-states become more open to international investment. That is true if there is enough stability in those governments to think about the long term, like in Saudi Arabia. If they think that they might lose power in the short term, they don't open up; they crack down. It's a tactical game. It's not a strategic game.

For Venezuela, the first thing they did after he won the referendum is, they went to nationalize Cargill. We are going to see more of that.

I think they are on the back foot, and I certainly don't see broader ideological support for a Chavista revanchism in South America.

On the Bolivian front, there's no question. It's a small country, but they are a problem and they are going to continue to be a problem because they have domestic secessionist impulses that they are also trying to crack down on.

But interestingly, I think the Bolivian-Brazilian relationship has shown more resilience than people think, and the Brazilians have shown a willingness to actually sit down and negotiate with these guys and not let it off the rails, in the way the Venezuelan-U.S. relationship has exploded, not from an oil-supply perspective, but from a U.S. investment perspective.

Bolivia is a place where, if you really know the politics on the ground and you are willing to work and deal with a lot of things, you potentially can actually make some money. But most of the Americans aren't prepared to do that.

QUESTION: You mentioned that you didn't see the United States as being a good investment in the medium term. Where do you think the private money is going to be going for the next, let's say, six to 18 months?

IAN BREMMER: By the way, I wasn't talking about the U.S. equity markets for domestic investors. I wouldn't call bottom there. Clearly, there are lots of cheap assets here, and different investment advisers will tell you different things. I'm simply making a structural call on the dollar. There will clearly be a lot of investment in the United States.

Again, a lot of that is going to be driven by where they think government is going to go. If people see massive money coming into infrastructure, then private equity funds are going to jump to be part of those partnerships—let's do some toll roads and let's do some bridges and let's do some schools and all that sort of thing. Clearly there is going to be a lot of interest there.

Do I think New York is going to attract a lot of that investment? I don't know. On the basis of a changing tax and regulatory environment, probably not. I think New York State is doing pretty much all it can to make New York comparatively less interesting as an investment over the medium to long term. I suspect that your office agrees with that.

But clearly the United States has scale, and scale is what has made the U.S. dollar good.

But another place that you have to be wondering about—who is wondering about the Swiss franc? Anyone? On the one hand, it's flight-to-quality. I know the fundamentals don't always apply. I'm not a currency specialist. But, my goodness, those guys have massive political risk. The G-20—and they are not a part of the EU—has just basically said, we're going to war with Switzerland.

We have Swiss bankers that aren't traveling to European states right now because they are actually concerned about arrest. What they are going to have to do to change their system, thinking about the stories that we are increasingly hearing about the banking of key Iranian businessmen that are connected to the Revolutionary Guards and all of this other stuff that is going to seriously change the Swiss model, that has to flow through to currency. Yet it isn't yet.

So I do think that there is some serious mispricing going on, because we have always thought that, like gold, the Swiss franc is a flight-to-quality play. If you are being advised by your local broker in rural Illinois someplace, you probably haven't gotten the story yet that the Swiss franc is actually potentially under siege from the G-20. I don't think local newspapers are writing that story. But I do think it's becoming important.

So there are some comments out there that are worth thinking about.

JOANNE MYERS: Unfortunately, the time is up, but I know that Ian will stay if you want to ask him questions.

Wisdom beyond your years. Thank you so much.

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