Saudi Arabia On The Brink

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The persistence of low oil prices is wreaking havoc in oil-producing nations, and no country is as vulnerable to the crude crunch as the Kingdom of Saudi Arabia. With almost three quarters of the government’s budget originating from oil revenues, the prolonged plunge in prices is a mortal threat to the Saudi monarchy.

Leaders are scrambling to secure a prosperous and stable future for the country. But are these maneuvers too late?

The blunt reality is that Saudi Arabia has grown accustomed to high oil prices. At their current level, the regime is facing a $100 billion budget deficit. The gap has forced the Kingdom to cut subsidies and secure its first outside loan in over a decade. Popular sentiment is rapidly shifting as citizens who once enjoyed cushy jobs are facing uncertain futures. Given the state employs two-thirds of native workers and youth unemployment is approaching 30 percent, the risk of social unrest is rising.


30-year-old Deputy Crown Prince Mohammed bin Salman has emerged with a plan to save the day.


Amidst the seemingly inevitable chaos, 30-year-old Deputy Crown Prince  Mohammed bin Salman has emerged with a plan to save the day. Dubbed “Vision 2030,” the plan has Saudi Arabia selling shares in Aramco, the state-run oil behemoth, and building a $2 trillion sovereign wealth fund. To put this number in context, it’s worth noting that the world’s largest sovereign fund (Norway’s Government Pension Fund) is valued at approximately $825 billion, according to the Sovereign Wealth Fund Institute.

The hope is to wean the country from its almost complete dependence on oil, enabling the nation "to live without oil" by 2020.  To achieve this transformation, the prince wants to completely overhaul the Saudi economy.  Key objectives of the plan include growing investment income, increasing small and medium enterprises as a percentage of the economy, and reorganizing and bolstering the domestic military industry.

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The young leader is confident. He recently told Bloomberg Businessweek that he doesn’t care about oil prices, noting the Kingdom’s advantage as a low-cost producer. He also wouldn't freeze production levels at the recent OPEC meeting in Doha because Iran refused to be involved.

Critics call the deputy crown prince naive and arrogant, while defenders see him as a youthful modernizer forcing necessary change.  He certainly thinks of himself as a modern leader representing a new generation, framing his ambitions with analogies to Bill Gates, Steve Jobs, and Mark Zuckerberg.

To reform Saudi Arabia is no trivial task. To begin, diversifying the economy might require international capital.  The Vision 2030 plan acknowledges its ambitions are dependent upon a "capital market open to the world."  Specific plans include the build-out of "special zones" with regulations designed to encourage investment.  Such investment-seeking hubs are planned for logistics and tourism, among other industries.

But simplistic plans like those announced this week are not going to be enough. Just consider the $10 billion King Abdullah Financial District.  With gleaming towers, cutting-edge technology, and a monorail connecting the district efficiently together, this 70% complete special zone has just about everything.  The one thing it doesn't?  Banks.  An April 2016 Bloomberg story noted that "not a single financial institution has agreed to take space in the 73 buildings" being constructed as part of the project.  Ooops!

The problem is complex, but it's increasingly clear that liberalizing and modernizing Saudi Arabia requires more than grand economic ambitions.


Liberalizing and modernizing Saudi Arabia requires more than grand economic ambitions.


Social reforms are also needed. The Kingdom severely restricts women’s rights, including the right to drive. Executions this year are on track to double last year’s total. The government employs strict anti-terrorism laws to crush dissent. And academics struggle to understand their role in an illiberal society where criticism can prompt a rapid and harsh backlash.

There are signs of progress, though. Vision 2030 includes plans to raise home ownership and revamp the education system.  In mid-April, the government announced that it would curb the powers of the religious police controlled by “The Commission for the Promotion of Virtue Prevention of Vice.” Further, women’s rights have begun to improve, and the deputy crown prince's plan includes boosting female participation in the labor force. (Interestingly, he also cautioned that the country is not yet ready to let women drive).

With Vision 2030, Prince Mohammed also signaled a pivot to openness by planning to offer green cards to foreign Arabs and Muslims, letting them work in Saudi Arabia for an extended period of time. The country is also going to greatly increase the availability of tourist visas, which today are only available to pilgrims.  According to the New York Times, "untrammeled beaches, ancient sites and unfiltered local culture are all on offer in Saudi Arabia."  Could the Kingdom turn into a tourist hot-spot?

Although progress is being made, the pace and magnitude of reforms may be inadequate to save the country.  While the deputy crown prince struggles to modernize the Kingdom, he’s also being buffeted by geopolitical forces increasingly unfavorable to Saudi Arabia.

In the Middle East, the country's rivalry with Iran has stretched its military, and the proxy war in Yemen—championed by the deputy crown prince—has been costly and sloppy. The Kingdom even offered to send ground troops into Syria to support Saudi-funded anti-Assad rebels.

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Moreover, Saudi-US relations have been strained. President Obama publicly criticized Saudi Arabia and its neighbors for being “free riders,” stating they needed to “share the neighborhood” with Iran. The US President’s visit to the Kingdom last week was fraught with tension; he arrived in Riyadh as a bill allowing families of 9/11 victims to sue Saudi Arabia gained traction in the US Senate and earned support from both Hillary Clinton and Bernie Sanders.

The mixture of economic weakness, military assertiveness, and a strained relationship with the US is a toxic cocktail. Perversely, it may now be in the country’s interest to provoke a conflict with Iran. Facing such radical uncertainty at home and abroad, the deputy crown prince must be both bold and humble as he implements his plan.  He should accelerate modernization, diversification, and liberalization efforts, and while the outcome of such an approach is far from certain, the risks of not doing so are rising every day.


What happens in Saudi Arabia is unlikely to stay in Saudi Arabia.


Saudi Arabia remains an extremely important country in the world.  What happens in Saudi Arabia is unlikely to stay in Saudi Arabia and as such, we must pay attention.  In the wise words of Yogi Berra, “it’s tough to make predictions, particularly about the future.” Nevertheless, we need to prepare for several possibilities, from the escalation of the cold war between Iran and Saudi Arabia into a hot one, to a collapse of the Saudi monarchy and the chaos accompanying such a development, to the emergence (if the deputy crown prince succeeds with his bold plans) of a renewed economic powerhouse in the Middle East.

One thing, however, is certain: The future of Saudi Arabia ain't what it used to be.

From Panama Papers to Blockchain Bonaza

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Early April's leak of documents detailing how global elites hide their money has put a new spotlight on the issue of financial secrecy. Power players throughout the world have been connected to shell companies set up by Mossack Fonseca, the law firm in Panama that was the victim of the breach.

The Panama Papers have already displaced the Prime Minister of IcelandSpain’s industry minister, the CEO of an Austrian bank, and—ironically—the head of Transparency International’s Chile branch. Thousands of protesters have also called on British Prime Minister David Cameron to resign. In response to the revelations, appeals for reform came fast, and Europe’s five biggest economies have agreed to crack down on abuse by sharing information.

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The leak raises an age-old debate on how to balance privacy and transparency. Many libertarian-minded privacy advocates think the future of financial secrecy lies not with tax havens, but rather with cryptocurrencies like Bitcoin and the blockchain technology that supports them. These digital currencies enable anonymous transactions, and so have become deeply associated with illicit financial dealings, like the drug trade on the defunct dark web marketplace Silk Road.

But it’s not that simple.  Blockchain advocates believe that the technology behind Bitcoin is the future of transparency, not secrecy.


Blockchain advocates believe that the technology behind Bitcoin is the future of transparency, not secrecy.


Bitcoin's crucial innovation is a distributed public ledger (known as a “blockchain”) that builds trust in a decentralized manner. Rather than relying on a single trusted source like a bank or clearinghouse, the blockchain defers to a decentralized swarm of machines. These computers are paid to verify transactions on the system. This network creates safety through redundancy, based on the consensus calculations of many machines. And, thanks to the decentralization and strong cryptography, dishonest dealers cannot go back and alter historical transaction records. To do so would require altering thousands of ledgers that are distributed globally. Every transaction that has ever taken place is available for all to see, even if specific transactions can’t be traced to specific people. As one writer succinctly put it, the blockchain is “transparent and tamper-proof."

This model of distributed trust offers a solution to the many social problems caused by a lack of open, trustworthy, and agile recordkeeping. At a recent event hosted by the MIT Center for International Studies, Blockchain expert Michael Casey noted that automating trust through public ledgers will streamline business and government transactions, destroying information bottlenecks and improving transparency and efficiency.

Consider, for instance, the domain of property titles. As Casey points out, the lack of formal title for many in emerging markets means they cannot collateralize their wealth. A distributed, immutable ledger powered by blockchain technology might unlock the wealth stranded by poor recordkeeping and title systems.

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Honduras, where 60% of land is undocumented, is trying this out, and another project is rolling out in Ghana. Using the blockchain to build property title databases should be an economic boon for people in these countries. It’ll also strengthen their democracies, since these systems have built-in safeguards against tampering with records, and thus corruption and expropriation.

Another area Casey noted as ripe for innovation is digital rights management. Blockchain technology could provide an elegant way for artists to get credited—and paid—for their work. Imagine a system in which “smart contracts” automatically pay photographers or musicians when their works are remixed. By automating the trust in such smart contracts, blockchain technology would minimize intellectual property theft and lower legal fees.

Despite its reputation for anonymity, blockchain technology could also be used for identification. Governments could create public ledgers to record births and deaths, reducing fraud in the procurement of government services. These systems could also bolster privacy by ensuring only needed information was accessible to agencies.

Healthcare is another area where blockchain logic could shine. The technology offers the prospect of encrypted medical records that hackers will have trouble tampering with. Estonia is currently implementing this kind of system. Other potential healthcare applications include drug verification and “DNA wallets.” With advances like these and others, storing medical information on the blockchain could simultaneously drive innovation in personalized medicine and also cut costs.

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As Casey points out, the new technology could also revolutionize supply chain management. Rather than having a single entity like Walmart hoarding valuable information about the flow of goods, a public ledger would allow everyone to see what’s where and when. Using a blockchain would also allow recipients of a good to understand its origin and ensure its authenticity.

Despite the potential for anonymity in financial transactions that Bitcoin offers, its underlying technology, the blockchain, is likely to make the world a much more transparent, democratic, and efficient place. It shouldn’t be lost on us, as Casey noted, that the biggest concerns banks have about the technology is that it is too transparent, not too secretive.

However depressing the Panama Papers revelations were, we can take solace in the fact that the future likely belongs to openness, not secrecy.

Skyscrapers Are Warning of Economic Chaos

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By 2019, Saudi Arabia is expected to be home to the world’s tallest tower. Developers plan to complete a 1-kilometer tall building in Jeddah. The Jeddah Tower has a design inspired by the growth patterns of desert plants and will soar 170 meters higher than the world’s current tallest building, Dubai’s Burj Khalifa.

But earlier this week, Emirati developer Emaar Properties announced that it too would construct a building taller than the Burj Khalifa—a stunning skyscraper designed by celebrated architect Santiago Calatrava Valls.  “The Tower” has an expected completion date in 2020 (in time for the Dubai-hosted World Expo) and is likely to have amenities such as observation decks, restaurants, and a hotel.  His Highness Sheikh Mohammed, the visionary ruler of Dubai, on Monday tweeted about his 1960s visit to the observation deck of the Empire State Building, then the world's tallest tower, and his dream to bring the world's tallest building to the emirate.  He also tweeted that "our dream is alive" with an image of the new tower.

The competition for the title of “world’s tallest” concerns me. As I wrote in my book Boombustology and described elsewhere, construction of the world’s tallest tower is usually a sign of hubris and overconfidence. And it’s often associated with bubbles.  A quick historical review of the world's tallest towers suggests today's scramble for height in the Middle East should be concerning.

In 1930, at the start of the Great Depression, 40 Wall Street became the world's tallest building, only to have the owners of the Chrysler Building erect a spire that robbed them of the title. Both, however, were outdone by the Empire State Building, which became the world's tallest in 1932. To read more about this historic race, I highly recommend the book Higher: A Historic Race to the Sky and the Making of a City.


...construction of the world’s tallest tower is usually a sign of hubris and overconfidence.


But NYC and the Great Depression were not the only instance of the world’s tallest skyscrapers and bubbles coinciding. Consider Chicago’s Willis Tower (aka the Sears Tower) and the World Trade Center towers in NYC. Completed in the early 1970s, they prefaced a period of stagflation that felt to many like a bubble bursting. And in Kuala Lumpur, the Petronas Towers were completed just before the Asian Financial Crisis hit Malaysia and Thailand in 1998. The pattern continued: Taipei 101, built at ground zero of the technology boom (at least in a hardware sense), was announced in 1999, not far from the peak of the technology bubble.

Taiwan held the title until 2007 when, within weeks of global markets peaking, the Burj Dubai was named the world’s tallest freestanding structure. Later renamed the Burj Khalifa, the tower opened during a Dubai debt crisis. Want a more recent example? Look East. Fourteen of the twenty tallest towers under construction today are in China.

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Before the Chinese slowdown became obvious to the world, China had plans to take the world’s tallest tower title from Dubai. A local developer hoped to build Sky City on a budget of under $1 billion in under 90 days. Interestingly, after China’s investment bubble burst, the foundation for Sky City has since been re-purposed as a fish farm. Oops!

But back to the Middle East, where nations are carrying out their bold construction plans while suffering from the consequences of low oil and gas prices. The commodity crash forced Saudi Arabia to run budget deficits, call into question the generous benefits it lavishes on its citizens, and even consider floating shares of its crown jewel, Aramco. The Saudi stock exchange is down by almost a third, the money supply has shrunk for the first time since 1994, and the credit ratings of local banks are slipping.

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The United Arab Emirates, while more diversified than its larger neighbor, has also been feeling the pain of the oil price shock. Dubai’s private sector economy contracted for the first time since 2009, property prices have been falling, and the government is mired in debt. This all comes as the emirate is, among other things, still trying to complete its bold construction of artificial islands off the coast.

Another Persian Gulf nation, Qatar, also appears overconfident in some regards. In 2015, it is believed that the Qataris set a world record price for a work of art, purchasing a Paul Gauguin painting for $300 million. The country already owned the previous world record (set in 2012) for paying over $250 million for a Cézanne. Now, analysts are warning that Qatar has gone through an unsustainable credit boom, which has inflated asset prices. Real estate values, for example, have doubled in the last four years.

And of course, there’s the upcoming OPEC meeting in Qatar. Analysts will closely watch what happens in Doha, where member states will try to negotiate an output freeze. Many are skeptical that any meaningful progress is possible; after all, most nations are already producing near capacity, making production increases highly unlikely from here. On top of that, Iran hopes to ramp up oil production as international sanctions are removed.

Last month, I had the chance to spend some time talking with noted oil analyst Daniel Yergin while I was in the Middle East. He expressed concern for the region’s ability to cope.  And more recently, he’s stated he believes OPEC has likely lost the power it once had to manipulate world oil prices. The pressures mounting on Saudi Arabia and others are rising.


OPEC has likely lost the power it once had to manipulate world oil prices...


All of these data points might easily be dismissed as noise. But I’d encourage you to look at them differently. Yes, it’s impossible to predict oil prices. Sure, the outlook for Middle Eastern economies is blurry at best. But looking broadly—at unconventional data points like the skyscraper indicator—can help us navigate radical uncertainty. And combining these insights with other developments can help us steer a path through these global economic cross currents. Maybe add this fact to the mix: the World Bank is currently receiving more requests for loans (outside of a financial crisis) than at any time in its history.

In times like these, we need to pay attention to the warning signs and proceed with caution.  We can hope for prosperity and continued growth, but it's best to prepare for continued uncertainty and possible economic chaos.

Buy the Book That Called the China Bubble

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Boombustology: Spotting Financial Bubbles Before They Burst offers a multidisciplinary framework for identifying unsustainable booms before they go bust.  It explains how a multi-lens approach can hep you navigate the uncertainty that plagues today's economic environment.  The framework will give you a perspective on dangerous dynamics that narrower approaches often miss.  And it seems to work!  The last chapter of the book identified the bubbly conditions at work in China back in 2011—when few were willing to acknowledge the precarious situation in the Middle Kingdom.  Looking forward, today's world promises an unending stream of booms and busts.  Reading Boombustology will provide you with the tools you need to avoid the next disaster.

 

Click HERE to purchase a copy.

 

 

 

All Clear! Stability Spreading and Growth Accelerating

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Anyone who's been following my thoughts recently will immediately recognize my headline as an April Fool's Day joke.  I am extremely concerned about the health of the global economy and see risks almost everywhere I look.

Last month I was invited to guest host CNBC's Squawk Box Europe.  During the hour I was on air, I discussed my views on global economic conditions and how they might constrain the Fed as well as the precarious fate of Silicon Valley's unicorns.  Click on the links below to see four short video excerpts.

Yale Academic Sees Bubbles Bursting Everywhere
Will Tech Unicorns Deliver on IPO Talk?
Rate Hikes Unlikely This Year
Mansharamani Says Data From China Is Biased

The world I see continues to be fragile, with widespread risks of both political and economic instability.  Interestingly, even the Fed is increasingly focused on global dynamics, as noted in Fed Chair Yellen's speech earlier this week at the Economic Club of NYC.  As I've argued, I think the Fed is unlikely to raise rates much (if at all) this year.

In other news, my Yale seminar on business ethics continues to be fun and engaging.  Since my last newsletter, guests have included senior leaders from Peter Kiewit & Sons, former president of Doctors Without Borders Unni Karunakara, manufacturing innovator Kevin Czinger, and Yale's legendary Chief Investment Officer David Swensen.  I feel really lucky to have such great students and guests who stimulate wonderful discussions.

For my weekly insights on navigating our increasingly interconnected and uncertain world, please follow me on my various social media channels. To stay up to date with my work on Facebook, please like my page here. Follow me on Twitter here and LinkedIn here. And for those receiving this email from a friend or colleague, you can add yourself to my mailing list here.

Best wishes for safe passage through today's global political and economic cross-currents.



Is China About to Mine the Moon?

China is rocketing forward with its ambitious space program.  Near-term plans include developing a Chinese space station and possibly mining the moon for helium-3, a potentially game-changing fuel for use in fusion.  Click HERE for my comment.


 

The $2 Billion Market for Passports

The rapidly growing market for economic citizenship shows no sign of abating anytime soon. Key drivers include desires among the wealthy for greater mobility and an insurance policy against home country instability.  Read my article HERE.


 

Syria & Climate Change

On the fifth anniversary of the Syrian conflict, I looked back at some of the factors that led to the violence.  A key culprit: climate change and a massive drought.   My post also explores lessons we might learn from Syria for navigating uncertainty.  Click HERE to read it.


 

Silicon Valley & Spies

As the Apple-FBI standoff grew increasingly tense, I reflected on the important and often dismissed power of empathy and how it could help de-escalate tense situations.  Click HERE to read my piece.


 

China's Trillion Dollar Silk Road

China's One Belt, One Road strategy has received scant attention in the Western media.  In this short article, I reflect on how this trillion dollar development program might be a modern day Marshall Plan that secures markets for Chinese goods and services for years to come.  Click HERE to read the article.


 

To Fix Europe, Break It

Amidst constant banter of a potential "Brexit," I penned a short piece that suggested Europe was terminally ill and that a British exit from the European Union didn't really matter.  There are much deeper problems.  Click HERE to read my argument.


 

Will India Ever Emerge?

As India celebrated its "Make In India" week, I reviewed the development strategy in light of Prime Minister Modi's stated goal that it would generate 100 million jobs.  Because of automated manufacturing technologies, India may have missed the window to replicate the Chinese, manufacturing-led development model.  Read more HERE.

 

To the Next President of the United States

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Dear 45th President of the United States of America:

I write to highlight five key issues that warrant immediate attention following your January inauguration. These topics demand you and your advisors think more long-term than we have in recent years. Solutions won’t be easy, but, having won a grueling election to secure your office, you will be well-positioned to champion them.

First, on immigration, we need to open our doors to the highly skilled. Too many brilliant non-citizens who want to contribute to our economy (including graduates of our world-leading universities) are not able to do so. Last year, 233,000 people applied for H-1B visas, a program for skilled foreigners capped at 85,000. With the US unemployment rate hovering near 5%, now is an opportune time to raise the quota. Economists have found that these individuals create jobsfor native-born Americans, and that artificially restricting their entry hurts American growth.


Too many brilliant non-citizens who want to contribute to our economy (including graduates of our world-leading universities) are not able to do so.


Look no further than Silicon Valley, where immigrants founded over half of the much-discussed private companies now worth over $1 billion. Regardless of whether these “unicorns” are valued correctly (I’m skeptical), their founders embody the risk-taking ethos that has made America great. Without reform, we will continue to mis-manage our most valuable resource: brainpower.

On top of that, we have a looming demographic crisis that immigration can help mitigate. We must not repeat Japan’s errors; the island country’s aging population has inflicted a stubborn economic malaise that Japanese leaders continue to fight.  A sensible immigration policy here in the United States would sustain our working population and bolster our supply of highly skilled workers.

As for the economy, in addition to ensuring a robust workforce, it’s also time to rebuild our inadequate, crumbling infrastructure. Our roads are congested, our bridges desperately need repair, and our airports are old and inefficient.

Like many Bostonians, I regularly commute via Storrow Drive. Of the hundreds of structurally deficient bridges in Massachusetts alone, the Storrow Drive Overpass is unique: it has been called the most dangerous bridge in America and has a government-designated sufficiency rating of zero.

The collapse of the Minneapolis I-35 bridge during rush hour in 2007 should have been a wake-up call. We need to update America’s infrastructure. Getting to and from work is stressful enough; one shouldn’t have to arrive in a cold sweat having played commuting roulette.

The costs of inaction are high. From the Flint water crisis to the D.C. Metro shutdown, the tragedies and inconveniences brought on by our failure to invest are increasingly evident. Addressing this problem requires hundreds of billions of dollars. There is no better time to do so than now: borrowing costs are low, and these investments will stimulate much-needed growth.

Beyond infrastructure, we must also confront our underfunded pensions. These ticking time bombs could generate mass social unrest here in the United States if left unaddressed. Unfunded liabilities tally into the trillions. California’s public pensions alone face an estimated $280 billion shortfall, and over half of American states have a pension deficit of over $10 billion. The culprits for these problems include dubious accounting practices, disappointing returns on investment, and, most of all, political neglect.

We need a non-fiction approach to managing pension liabilities.  Just as President Obama appointed an executive compensation czar, you should appoint a pensions czar to help states address their unfunded liabilities.


We need a non-fiction approach to managing pension liabilities.


On climate change, we must adopt a more comprehensive approach by considering the full environmental cost of seemingly eco-friendly technologies. We’ve made good progress with alternative energy, but we can and should do more. A technique called life-cycle assessment looks at the entire impact a product has on the environment from cradle to grave.

Using this methodology reveals how we often fail to fully consider the significant environmental footprint of manufacturing processes—even for "green" products like electric cars and solar panels. There are already some innovative developments on the horizon promising to address these issues. For example, Divergent, a company highlighted by Google as a “moonshot” innovator, is working to perfect a technique for 3D printing a lightweight car chassis.

Kevin Czinger, the company’s founder, believes his manufacturing process could dramatically reduce the environmental cost associated with automobile production and provide a template for other industries. Producing green technologies in an environmentally friendly manner should be a key part of any strategy to address climate change.

We also need to ensure our nation’s long-term resource security. The environment of cheap industrial and energy commodities we’re currently enjoying must not lull us into complacency. Historic cuts in oil investment may eventually lead to a price jump, even if its timing is impossible to predict.

In the not-too-distant future, unconventional regions for energy extraction will become the focus of strategic jockeying, from outer space to the Arctic. Space cowboys from China to Silicon Valley are already eyeing the moon’s helium-3, a promising potential fuel for nuclear fusion that is lacking on Earth. Continued support for our space program is essential if we don’t want to cede our leadership position to the Chinese. And we must not let any nation dominate the resource-rich Arctic.

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Next January, when you finally settle into the Oval Office, you’ll be faced with the reality of these and many other issues—from tax reform to trade agreements, from healthcare to the Supreme Court, from Iran to Russia.  As you lead our nation through the extreme uncertainty that typifies the world, I encourage you to look broadly, beyond the silos that derail effective deliberation and policy-making.  Not doing so risks crashing our national ship on partisan rocks, while adopting multiple perspectives can ensure safe passage across increasingly choppy waters.

We need broad-minded, far-sighted leadership now more than ever.  I wish you the best of luck...you're probably going to need it.

Sincerely,
Vikram Mansharamani

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