Foreign Policy Blogs

SIGNALS: A Candid Discussion with Dr. Philippa Malmgren

Photo Credit: CH'7K via Flickr

Photo Credit: CH’7K via Flickr

Dr. Philippa “Pippa” Malmgren is the Founder of DRPM Group, a firm based in London that researches risks that are not easily quantified, namely politics, policy, and geopolitics. She also founded H Robotics, a manufacturing firm in the U.K. A graduate of the London School of Economics, Dr. Malmgren is a member of the Council on Foreign Relations, Chatham House, and the Institute for International Strategic Security. She has written for Wired, The International Economy, and Monocle.

PM.jpgDr. Malmgren served as an adviser on international economic issues for George W. Bush during his first presidential campaign. She subsequently joined the Bush White House, where she was Special Assistant to the President for Economic Policy on the National Economic Council and a member of the President’s Working Groups on Financial Markets and Corporate Governance. She also served as a member of the White House Office of the Homeland Defense Working Group on Terrorism Risks to the Economy.

Paul Nash of the Foreign Policy Association spoke with Dr. Malmgren about her new book Signals: The Breakdown of the Social Contract and the Rise of Geopolitics, which was published recently in the U.K. by Grosvenor House Publishing Limited.

Q: In your new book, you say that economic signals are everywhere, from magazine covers to grocery stores to military events. What exactly do you mean by “signals”?

PM: Too often we think about economic data to the exclusion of other important information that matters. There are lots of sources of information that signal what is happening in the world economy. For example, military events like the recent near misses between American spy planes and the fighter jets of China and Russia are an important signal that the peace dividend is eroding and a new conflict premium is becoming apparent. That has economic and geopolitical implications. I find that magazine covers and artwork are good signals, which can reveal important things about the state of the world economy. Record prices for artwork and hard assets reveal a loss of faith in savings. This is not surprising given that governments now penalize savers with negative returns. One problem with data points is that they are backward looking and only serve to confirm the past. If you want to prepare for the future, you have to widen the “signals,” or sources of telling information you consider, well beyond numbers.

Q: How is one able to recognize these signals and know what they mean, or how to interpret them?

PM: No one can predict the future. When I served in the White House, everybody assumed we had a crystal ball. But I really looked and there isn’t one there. The best you can do is to raise your level of awareness and preparedness. For example, when I saw that food prices were rising in Ukraine for three years, I assumed this would destabilize that country. Sure enough, Ukraine has descended into a difficult mess. Similarly, the rising bread price that preceded the outbreak of the Arab Spring was an important signal. Global food prices at that time were steady or falling.

But people don’t care about aggregate food prices. They care a lot when the price of their core food staples starts to rise. There’s a pretty strong correlation between rising prices for core foodstuffs and social unrest, and yet few people really look at this, either in markets or in foreign policy circles. I mean who follows the price of onions in India or Pork in China? Yet if these prices rise, it is sometimes enough to threaten social stability.

Q: Can signals be misread? And how do you make allowances for those signals you may have missed altogether?

PM: Sure, signals can be misread. The key thing is that everybody will (and should) interpret signals differently. They will (and should) also act on them differently. There is no one right answer for all of us. It is the diversity of opinion and capability that makes the economy strong. After all, it is a marketplace with buyers and sellers of every signal and every idea. Some will be right. Some will be wrong. And yet humans love to approach things in a binary way, asking questions like: Will the market go up or down, should I be long or short, will a country like China or Russia become a more open or a more closed society? But the reality is that some things rise in a falling market, some countries can become more open on some aspects while simultaneously becoming more closed on others. The answer is to be more focused on differences of opinion and dissent, and wary of assumed outcomes. What John Stuart Mill observed in his day still holds true: “That so few now dare to be eccentric, marks the chief danger of the time and all good things which exist are the fruits of originality.”

Q: Can signals replace the complex mathematical models that governments or corporations use to inform their decisions?

PM: John F. Kennedy hired Robert McNamara to be the secretary of defense because he thought that his heavy use of math and data at Ford (in logistics and supply chain management) could make government more efficient. In some ways, the management of data has improved the workings of government. But when it came to a mathematical analysis of what was happening in the war in Vietnam, that approach ended in tears and a lot of spilled blood and treasure. McNamara wrote: “We were wrong, terribly wrong. We owe it to future generations to explain why.” The point is that not everything that matters can be measured, as Einstein reminded us. Many things that matter need to be weighed rather than measured. The level of human pain is something we can weigh against other factors, but it is remarkably hard to measure.

Q: Can signals be integrated with Big Data? 

PM: Math and Big Data have their place. But there are other signals that ought not to be ignored just because they can’t be easily quantified. I love the quote by Daniel Yankelovich, the founder of modern polling, who said: “The first step is to measure whatever can be easily measured. This is OK as far as it goes. The second step is to disregard that which can’t be easily measured or to give it an arbitrary quantitative value. This is artificial and misleading. The third step is to presume that what can’t be measured easily really isn’t important. This is blindness. The fourth step is to say that what can’t be easily measured really doesn’t exist. This is suicide.”

So keep your eyes open for non-data signals. The willingness of a person to commit suicide over a public policy issue, for example, is something “big data” might find hard to reveal. Yet when a young vegetable seller in Tunisia or a Greek worker in Athens or a Buddhist priest in Tibet do this, it reveals a broader set of social pressures. 

Q: How can signals help governments make better public policy choices?

PM: The first thing is to understand that there is always a social contract between the government and the citizens. Citizens abide by the law and pay their taxes, and in exchange they expect the government to deliver certain outcomes, from reasonably frequent trash collection to a military.

These days, the social contract is under severe pressure because governments everywhere are too broke to fulfill the promises they have made. So they deliver less and tax more. In response, citizens who have faith and trust in a ballot box tend to use it, and those who don’t head to the streets. So it is important for government leaders to be alert to the limits of pain.

For example, in the eurozone there may well be a government commitment to the euro project, but if people begin to believe that the price of unification is that everyone from age 16 upward will never work, the public may decide the price is too high because it profoundly breaks the social contract. We may assume that Russia is [broken], and yet this does not preclude them from bringing nuclear weapons back onto the global landscape; in fact, being broke may encourage this outcome. Failure to adopt a tough stance might well break the social contract in Russia. We could make better public policy choices by being more alert to signals about the condition of the social contract.

Q: You say that innovation can alleviate wealth inequality in the United States and around the world. How does that happen?

PM: In my view, redistribution of income won’t work. The debt problem is simply too big. You could tax Americans 100 percent of their income – all of them – and still be left with a multiyear hole. So efforts to consolidate debt and spending (which have been remarkably limited so far) need to be accompanied by more growth. Happily this is occurring. For example, I see many signals that manufacturing is leaving China and Asia and re-shoring to the U.S. Midwest and Mexico. Wages in China are rising too high and too fast. Buyers care more about quality now and prefer more reliable products. So the innovations in additive manufacturing and 3D printing in the U.S., combined with China’s loss of relative competitiveness, is now challenging the Politburo. If they cannot make people rich before they get old, then they’ll face dissent. The government must support innovation of China’s business model as they move away from cheap exports to higher value-added domestic consumption.

People think of innovation far too narrowly. It is not just about some new iPhone. It is also about the ability of the citizens to redefine themselves and the work they do. It is about new business models. It is about redefining the social contract.

Q: What other signals are you seeing today in the global economy?

PM: I see signals that inflation is coming back onto the global economic landscape. It’s pretty unsurprising given that every major central bank in the world, including China’s, is doing its level best to create it. That’s the whole point of super low interest rates and quantitative easing. But even low-level inflation brings serious social problems. I think emerging markets are rendered increasingly unstable by cost pressures their citizens cannot easily manage. In the industrialized world, the rise of inflationary pressures means there is an ever deeper split between the rich, who see asset prices rise (the normal consequence of provoked inflation), and the poor who find their costs, like rent, go up (which is also a normal consequence of inflation).

This admittedly very mild inflation pressure is already enough to have enraged the leadership in China, Russia, and other emerging markets. Their view is that the U.S. and the West seek to default on them through inflation. This means much more than making a trading loss on their holdings of U.S. Treasuries. They think the U.S. is playing Russian roulette with price stability. A little higher inflation for emerging markets gives oxygen to social unrest. So they see it as the Goldfinger Problem: the U.S. defaulted through inflation in order to pay for the American Revolution; it inflated its way out of the Civil War debt this way; it “paid for” Vietnam and the Great Society Program through inflation, too. As Goldfinger says to James Bond: “Once is happenstance. Twice is coincidence. Three times is enemy action.” They are now inclined to reach for assets more aggressively in order to protect their populations from the consequences of price instability. The Chinese become more aggressive in the South China Sea because they can’t feed themselves and that’s where you find 10 percent of the world’s fish supply in a world that has record high protein prices. This draws the U.S. into the South China Sea more aggressively, too.

As a result of all this, we are seeing near misses between U.S. spy planes and Chinese fighter jets, and both countries agreeing to the establishment of a hotline between Beijing and Washington in case these planes come within less than a coat of paint of each other. The U.S. has recently announced its intention to move more military assets into the areas where China is building infrastructure in the South China Sea. It’s not hard to imagine uncomfortable results from all this.

Q: Can you talk a little more about what you call “the breakdown of the social contract and the rise of geopolitics”?

PM: I think there is a vice bearing down on every nation, every company, every family and every individual. People are caught between, on the one hand, the debt problem, which brings low growth, no income, and a loss of faith in the future, and inflation on the other hand, which raises the cost of living (even if only by a little bit). The combined pressure gives rise to a powerful political question: Why is the wealth in my society going to someone else and not to me? This question underpins social protests from the Arab Spring to election discussions in the U.S. Domestically, the inability of the government to meet everybody’s needs due to financial shortfalls means more social pressure as different parts of society jockey for the money.

Internationally, nations respond to a breakdown of the social contract by becoming more aggressive in seeking to protect their citizens from adverse outcomes.

Q: You argue that economic signals are now eliciting more than economic policy responses – that they’re also provoking military events.

PM: Yes, I think we are seeing a new twist on Clausewitz. He said, “War is a continuation of politics by other means.”

Today, I think, we are seeing military confrontation as a continuation of monetary policy by other means. The Federal Reserve and U.S. authorities will scoff at this notion. They say that U.S. monetary policy and quantitative easing have no spillover effects. This leaves emerging markets incredulous and outraged. Even if there were any such spillovers, the U.S. argues that emerging markets should just raise their interest rates and let their currencies appreciate.

Emerging markets are even more outraged and incredulous at the idea that they should have to take even more pain when the whole slowdown happened due to spending excesses and lax policy in the West. Their response is to gird for inflation by reaching for hard assets, from food to infrastructure. This creates a kind of new Great Game situation in which China and Russia focus on physical footholds wherever there are resources, from the Arctic to the Baltic, and from the Atlantic to the Pacific.

Q: What do you say to politicians or policymakers who tell you they “don’t do economics”?

PM: I say they had better “do economics” whether they like it or not, or else economics will “undo” them. There is no way to check out of the world economy. It touches our lives every day in multiple ways.

Here is an interesting example of the interface between economics and geopolitics. Russia’s prime minister recently said that if the West kicks Russia out of SWIFT, the “Russian response – economically and otherwise – will know no limits.” The defense community asks, “What is SWIFT?” because they don’t know anything about the international banking and money clearing system that it represents.The market crowd assumes Medvedev’s “no limits” language means he is threatening to announce that Russia has more gold than America and is therefore more creditworthy. But what Russia probably means is that it will put nuclear weapons and capabilities into places like Kaliningrad and Ukraine and establish a military presence in places like the Mediterranean and the Arctic. The old nuclear weapons treaties will no longer hold for Russia. Add to this Russia’s efforts to test the West by engaging in air and sea incursions, from Japan to Scandinavia, and from Britain to California. Nobody knows which planes or vessels are loaded.

So the West has to respond as if it is a nuclear threat, even if it isn’t. You might say Russia is pulling a “Ronald Reagan trick” on the U.S. Where Reagan forced them to spend (on defense) beyond their means, Russia is now forcing the U.S. and the West to do the same at the very moment there are fewer financial resources to support this. Economics and geopolitics are deeply intertwined.

Q: Is it fair to say that as economic factors are changing the balance of power between the state and the citizen, they are also causing a realignment of international political interests?

PM: I think they are. Consider this. The postwar international economic system is built on certain basic ideas. It is a U.S. dollar-based system of free trade and (relatively) free markets, supported by certain rules of the game and certain institutions like the IMF and the World Bank. Ever since the financial crisis, the U.S. and the West with Japan have focused on repairing that system. China, Russia, and others have focused on replacing it. Why? Because they feel the old system is no longer serving their interests. Meanwhile, those in the old system are surprised that anybody feels their interests are not being served. Those who want a new system are surprised that anybody thinks that the old system is still worth repairing.

This has serious practical consequences. For example, in the old days China recycled its savings into the U.S. debt market and thereby helped to drive down interest rates and drive up the size of houses and mortgages in the U.S., which led to more purchases of stuff from China and more jobs and savings for them. It was a “perfect circle.” It permitted the U.S. (and the West) to live beyond its means, and China to grow faster than normal. This perfect circle cracked under the burden of debt. Now China says: forget recycling to the U.S. – let’s put our money directly into global infrastructure that will help us generate more GDP and potentially shore up our influence over the global supply chain. One new institution they have created to do this is the Asian Infrastructure Investment Bank. The U.S. was shocked and angry when Britain decided to join the new entity. Now some 54 countries have joined. The U.S. will not have a seat at that table. All this constitutes a profound shift in the balance of power within the system and a substantial change of the system itself.

Q: Are some states – countries like Russia and China – beginning to come together in ways that pose a real threat to the supremacy of the United States?

PM: I think the U.S. remains the main superpower in the world today. It is winning back some of its lost competitiveness, while emerging markets become less productive and less competitive. I never bought into the “U.S. is toast and China is the future” story. Both countries have their strengths and weaknesses. Both are internationalizing. Both are becoming more sophisticated economies. But they are also more competitive and more confrontational with each other. The prospects for difficult conflicts are growing. It is no longer true that the alignment of their interests outweighs whatever misaligned interests may exist.

People worry about the demise of the U.S. I have the opposite worry. I am concerned about a billion Chinese workers who were expecting a better future. We cannot expect to say: I am terribly sorry but you lost your competitiveness – come back when you have a new business model. They may not go home quietly. And why should they? The promise of a better life is real. The question is: How should they get there?

Also, what does “supremacy” mean in a world where technology has transformed the battlefield. This is a world in which wars are fought in cyberspace and in space with high altitude satellites. This is a world in which the commercial competition for ownership of commodities and industrial intelligence may be more worth fighting for than wars with boots on the ground.

China and Russia are certainly compelling former U.S. allies to think about which side they are on. Countries like Australia, Singapore, Saudi Arabia and even Britain are tied to the American defense stance but increasingly dependent on China’s economy. As the U.S. and China become more confrontational, countries will feel the pressure to choose sides. We see the same thing in Germany. Germany sees that its economic future lies to the east now that growth in the eurozone is impaired. Germany depends on Russia for energy. The U.S. asked Germany to join the famous Five Eyes spying program in an attempt to strengthen their relationship.

Russia has offered Greece cash to leave the euro, the European Union, and NATO, and to join the new Eurasian Economic Union. Greece is split between a U.S.-based defense policy and a need for Russian cash.

Saudi Arabia is a U.S. defense ally. But the U.S. supports opening up to Iran and permitting them to have some kind of nuclear capability. The U.S. supported the rebels in the Arab Spring, which is obviously not helpful from the Saudi royal family’s perspective. Meanwhile, China has become a bigger buyer of its oil than the U.S. So Saudi Arabia is drifting out of the U.S. relationship and into a new one with China.

But the flip side is that manufacturing is moving back to the U.S. from China. The Chinese are becoming less competitive very rapidly due to higher costs and higher wages. The idea that China is on a linear trajectory in which it displaces the U.S. is not quite right either.

Q: Do you think the high levels of U.S. government debt held by foreigners should concern Americans?

PM: Americans, generally speaking, have no idea they owe money to foreigners. I mean nobody they know has actually taken out a loan from a Chinese bank, right? Plus, Americans tend to think there are U.S. dollars and then there is Monopoly money. Why would anyone prefer Monopoly money? It’s hard to fix a problem you don’t know you have.

Also, almost every other government has an overwhelming debt problem, including China. Relatively, the U.S. has more capacity to earn and to grow than many other less flexible and less dynamic economies. So Americans are perhaps right to be less concerned than some others about their debt problems. This does not mean the U.S. gets a free pass. But it does mean the market does not punish the U.S. as hard as some might expect.

Q: Since the end of the Cold War, there’s been a general sense that the world is now a safer place because the threat of nuclear war between two rival superpowers has greatly subsided. Do you think that’s actually the case?

PM: I think that nuclear weapons are definitely back on the landscape. Russia is bringing nuclear weapons back to the negotiating table. The interesting thing is that the Western defense community wonders why. I mean Russia is supposed to be small and weak and broke, right? The problem is that this may be exactly why a nation falls back on hard power. I follow the various occasional news stories about their reintroduction. For example, Russia has threatened Denmark with nuclear weapons. General Breedlove, the head of NATO, says Russia’s rhetoric and actions regarding nuclear capability “give pause to NATO’s decision-making.”

I think we are also witnessing the nuclearization of the Middle East. If Iran and Israel are nuclear weapons powers, then everybody else wants to be too. Saudi Arabia will be working with both Russia and China, who are keen to export nuclear capability from a revenue perspective and keen to become more deeply tied into the region from a strategic perspective. Turkey and Egypt will follow suit.

Lastly, we should pay more attention to hypersonic technology. Nuclear weapons now may be just as destructive as they ever were. But the ability to deliver them at speed has been enhanced by modern technology. The Cuban Missile Crisis lasted ten days. These days, nuclear weapons can be delivered in minutes and seconds. Time is no longer a luxury. We need to think about managing the relationships and the dialogue well in advance of something really confrontational. As I understand it, we no longer have a hotline between Moscow and Washington. Maybe we should think about that.

Q: What does the world need in order to achieve greater geopolitical stability and security?

PM: We have to think seriously about whether the current infrastructure and rules of the game really serve the national interests of the participants. If they don’t, the system will inevitably erode. We should try to align national interests. Right now more and more countries are getting caught in the crossfire between the U.S. and China, and the U.S. and Russia. China asks Australia, Singapore, and the U.K. “Which side are you on?” In each, the economy is tied to China but the defense policy is tied to the U.S. As the U.S. and China go nose-to-nose in space and on the high seas, these countries will increasingly need to either choose sides or act as interlocutors who can talk both the U.S. and China out of doing anything stupid.

We also have to understand that weakened budgets lead to weakened borders. For example, Greece has thrown open all the detention centers for illegal immigrants because they have no cash. Now the refugee problems in the Mediterranean are exploding. The Sykes Picot Treaty borders of the Middle East are disintegrating and further contributing to this. Weak economies are also encouraging an exodus of talent, which seeks to traverse borders in search of better opportunities.

At the heart of all these forces lies economics. Stronger economics would improve geopolitics.

 

Author

Paul Nash
Paul Nash

Paul Nash produces FPA’s "Candid Discussions," an interview series with influential policy makers, writers, and media personalities in the field of foreign policy and international security. A Senior Editor at Diplomatic Courier magazine (www.diplomaticourier.com), he is also a member of the National Press Club of Washington, D.C., serving on the Newsmakers Committee.

Paul obtained his B.A. and M.A. from the University of Toronto and his Ph.D. from the University of Edinburgh.

Twitter: @PaulNashDC

americasdiplomats_socialmediaasset