Will The Next War Be In The Arctic?

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Earlier this month, Norway held its “Joint Viking” military exercises in Finnmark, the country’s northernmost province that shares a border with Russia. Involving 400 vehicles (6km if they were put end to end!), over 5000 troops, submarines, surface ships, and Air Force fighter jets, these war-games were the most extensive in 50 years. The last time Norway held military exercises in this region was 1967. (Click HERE for more about “Joint Viking”).

Just as this demonstration of Norwegian force was concluding, the Russian military began an even larger military exercise involving 40,000 servicemen, 41 warships, 15 submarines, and an undisclosed number of fighter jets. All of this was on the heels of Russia’s December announcement (click HERE) that it had formed a new strategic command to defend its interest in the Arctic and approximately 18 months after it began re-opening previously abandoned airbases in the region (click HERE).

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Meanwhile, Canada recently announced a C$3.6 billion order of five highly specialized naval vessels (Arctic Offshore Patrol Ships) that would, among other tasks, “assert and enforce Canadian sovereignty when and where necessary” (click HERE). These ships are part of a C$36.6 billion National Shipbuilding Procurement Strategy that includes the acquisition of Canadian Surface Combatants to “monitor and defend Canadian waters” (click HERE). Last summer, Canada’s NATO delegation exchanged aggressive tweets (that went viral) with a Russian delegation about geography and sovereignty (click HERE to see the tweets) and Canadian Premier Stephen Harper vowed to reassert Canada’s territorial sovereignty in the Arctic.

Over the past few years, many other nations have articulated an Arctic strategy.   The list includes the United States (click HERE), China (click HERE), Sweden (click HERE), Finland (click HERE), Denmark (click HERE), Iceland (click HERE), Japan (click HERE), Korea (click HERE), Singapore (click HERE), and even India (click HERE).

Why the sudden surge of interest in the region? One of the primary drivers, I believe, is climate change. As polar ice melts, natural resources become accessible. According to the USGS (click HERE), the Arctic contains “about 22 percent of the undiscovered, technically recoverable resources in the world,” most of which remain offshore.   The fact that tensions are rising at current oil prices is concerning given diminished economic incentives (click HERE).  Might higher oil prices catalyze conflict?  The strategic navigation lanes that are opening up as temperatures rise are another motivation. The amount of cargo transported through the Arctic has been rising rapidly and voyages through the Northwest Passage might reduce travel time for certain trips by as much as 40% compared to using the Suez or Panama canals.

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Another explanation for escalating tensions may be Russian aggression in Ukraine and the resurgence of NATO’s relevance. While organizations such as the Arctic Council exist to enable multilateral dialogue, Russian tolerance for Western dominated institutions has been waning.   Given that Canada currently chairs the Arctic Council and the US is set to take over that position later this year, multilateral efforts to maintain peace in the Arctic may prove futile.  In fact, Duncan Depledge recently suggested the Arctic could be the next Crimea (click HERE).

In thinking about global risks, it’s worth considering the possibility of war in the Arctic and the ramifications for Russia, Norway, Canada, the United States, and other nations. Although the risk currently seems low, like temperatures and tensions, it’s definitely rising.

 

 

Crazy Canadian Credit Confronts Crude, Eh?

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Canada is in the midst of a unprecedented housing boom that seems likely to bust. I was recently in Canada and noticed a schizophrenic oscillation between housing exuberance and oil-price despair. What did it mean for the Canadian economy’s outlook? Upon returning to the US, I did some research. What I found leads me to the conclusion that Canada is now among the most vulnerable large economies in the world. Here’s why.

First, household credit. The seemingly conservative Canadian population has been voraciously consuming debt at a breakneck pace. Total household debt (C$1.82 trillion) now exceeds GDP (C$1.6 trillion), approximately C$1.3 trillion of which was for residential mortgages (Click HERE). Further, household debt is now >160% of disposable income – meaning it would take ~20 months for a family to pay off its debt if interest rates were 0% and they spent 100% of their disposable income to do so. Uh oh! The consumer clearly seems stretched, so much so that McKinsey recently suggested Canadian financial instability driven by a rapid consumer slowdown was not unlikely (click HERE).

Second, housing prices. Home prices continue their basically uninterrupted rise that began in the mid-late 1990s. Unlike the United States real estate markets, which have corrected, Canadian prices continue to rise.   Detached single-family homes in Toronto now average more than C$1 million and Vancouver is now deemed the second least affordable city in the world (click HERE) – thanks to Chinese buyers (who are themselves facing a slower economy). Take a look at the following chart of US and Canadian housing prices in real terms since 1990.

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It’s interesting to note that the data in this chart is updated through the summer of 2014 (click HERE), and we know that prices have risen since then. In fact, the Bank of Canada even suggested in December that housing prices were overvalued by as much as 30% (click HERE). The IMF has also sounded warnings.

Third, crude oil. The impact of lower oil prices is rippling through the economy at breakneck speed. Since 2011, Alberta, the oil-rich home of the oil sands, was responsible for more than 50% of all jobs created in Canada. It has literally been the locomotive of job creation pulling Canada forward. It’s now in reverse. Employment growth has stopped in Alberta and is now shrinking. According to construction industry association BuildForce, Alberta is likely to see sustained job losses for the next three years at a minimum (click HERE). Further, because Alberta drew workers from all over the country, any provincial slowdown will have national ramifications on unemployment and consumer confidence (click HERE).

Finally, craziness. Yup, not sure how to better categorize what I’m about to say. Here’s the situation, as told to me by Seth Daniels of JKD Capital, one of the most astute Canada-watchers I know. Seth told me that there is now a booming private mortgage market in which ordinary citizens are borrowing from their home equity lines to lend money to desperate borrowers. Specifically, he noted “a homeowner acts as a subprime lender by drawing a HELOC at ~3% interest-only, and lends it to a subprime borrower at 8-12% for one year (interest only).” I honestly didn’t believe him when he first mentioned this to me, but I then confirmed it myself (click HERE).   In fact, if you’re a Canadian and interested, here’s a sales pitch from one vendor (click HERE). It’s only a matter of time before this shadow mortgage banking market slows, and the ramifications are likely to be enormous.

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Net net, the ending of the Canadian credit binge, combined with an oil-driven economic slowdown, is likely to crush consumer sentiment.  In this Loonie tune, it seems our Crazy Canadian Coyote has run off the cliff, his feet are still moving, but he has yet to look down. He’s suspended in air, and it’s only a matter of time until gravity exerts its force.

 

 

Robot Boom to Socioeconomic Bust?

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The robots are coming! From manufacturing to journalism, technological automation seems to be infiltrating virtually every component of modern economic life. Robots have enhanced productivity at dairy farms (see HERE), replaced African children as jockeys for camel racing in the Middle East (click HERE), improved the speed and accuracy of fulfillment logistics at Amazon (click HERE), and even begun writing articles and books (click HERE). Robots are entertaining audiences with dance performances (click HERE) and rock concerts (click HERE). Narrative Science, a company that trains computers to write articles, estimates that more than 90% of news stories will be written by robo-journalists within the next 10-15 years (click HERE), while robo-advisors are already starting to manage large pools of money (click HERE).

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Even the industrial robots that for decades have augmented factory workers at manufacturing sites are now taking on bigger roles. Prior to exiting the plasma TV business, Panasonic had a facility outside of Osaka that produced 2 million TV’s a month, with approximately 25 employees.   Canon, the world’s largest maker of digital cameras and lenses, plans to remove all humans from manufacturing. And Foxconn, a Taiwanese manufacturing giant that manufactures many Apple products and has more than 1 million employees, plans to have 70% of its assembly-related work completed by robots in the next three years (click HERE).

So What? When thinking about the impact of robotics on our socio-economic lives, I focus on three key questions that I believe we should try to answer.

First, will robots create or destroy jobs? While conventional wisdom suggests that substitution of workers with robots destroys jobs, I don’t believe it is that simple. Schumpeterian creative destruction allows for innovation and investment in new industries and may in fact create jobs (click HERE). But in the short run, it may be lower aggregate wages/income, dampen prices for goods, and keep the lid on inflation.

Second, will robots make us richer or poorer? Because robots allow for a de facto transfer of economic gains from labor towards capital, there is a reasonable concern that the productivity gains will not flow to workers. Might this exacerbate the already problematic levels of inequality in the world today?  What are the possible social reactions to such developments?

Third, how will robots affect the geography of manufacturing? I believe robots will have a huge impact. Why bother putting factories where labor rates are cheapest if labor is an increasingly miniscule component of costs? Might it make more sense to put facilities near demand?  Given the large American consumer market, does manufacturing return to the United States?  What does this mean for emerging economies that are hoping to use low-cost labor to incentivize manufacturers to hire locals?

In closing, it’s worth recalling the oft-recounted tale of Henry Ford II showing a newly automated factory to United Auto Workers union boss Walter Reuther. Ford asked how Reuther was planning on getting the robots to pay their dues. Without missing a beat, Reuther responded with “Henry, how are you going to get them to buy your cars?”

To Fly High, Focus on Customers…Not Competitors

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Next week marks the 13th anniversary of an “Open Skies” agreement between the United States and the United Arab Emirates (click HERE). Since it was signed in 2002, Etihad and Emirates, two UAE based carriers, have made successful expansions into the US market by focusing on service quality and the customer experience.

I recently flew Etihad Airlines, the state-owned carrier that has grown like a weed since it was founded in 2003. Despite the inherent discomfort of spending 14+ hours in a metal tube flying at 500+ mph at 37,000 feet over the surface of the earth, I actually enjoyed the experience! The service was great, the food delicious, the entertainment system robust, and the WIFI efficient. (Click HERE for more about Etihad’s service).  I flew Emirates earlier this year and had a similar experience.

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When I contrast these experiences with those I’ve had flying US carriers internationally, the difference is enormous: seating is not as comfortable, the food of lesser quality, and the service far less accommodating.   The entertainment systems are less capable, the staff is generally less friendly, and the equipment is definitively older.  Simply put, the offering is not nearly as good.

As a voracious consumer of international air travel services, I vote with my feet and choose the best offering available for the price.  I'm thrilled to have Emirates and Etihad as options.  As a student of service companies, I had expected the US airlines would improve their long haul offerings.  Sadly, they appear more concerned with competitors than customers.  While they’ve marginally improved, American, Delta, and United are also asking the US government to renegotiate the Open Skies agreement (click HERE).

Airline executives from the US carriers recently submitted a 55-page document to Congress (not released to the public) claiming the three main Persian Gulf carriers (Emirates, Etihad, and Qatar) are competing unfairly through government subsidies. Delta CEO Richard Anderson noted he spent two years studying the Gulf carriers’ financial statements and had indisputable evidence of tens of billions of dollars in subsidies, escalating tensions between executives from the United States and the Gulf Carriers.   But don't many nations support their airlines?  In a position paper, Emirates actually highlights the subsidies received by dozens of carriers from dozens of nations (click HERE).  Qatar Airways CEO Akbar Al Baker commented “Mr. Anderson should be doing his job and improving and competing with us instead of crying wolf for his shortcomings in the way his airline is run” (click HERE).

What if Delta’s Anderson had spent two years focused on customers instead of his competitors?  In an interview with Matt Winkler, Emirates Chairman Sheikh Ahmed Bin Saeed Al Maktoum offered simple yet powerful advice to his American competitors: “Improve your service, offer the best to the passenger, and people will fly with you”(click HERE).

To fly high, focus on your customers, not competitors.

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