“Let China sleep; when she wakes, she will shake the world.”
– Napoleon, 1817 (citation source: Graham Allison)
“We really don’t think it was tariffs – those have been in the public domain for days. Rather, we believe the market has a very unhealthy dynamic at the moment. Washington policy is critical to the market direction, but information asymmetries there are profound. No one wants to buy the dip if a real seller with better DC sources caused it.”
– Datatrek, March 22 (Kotok note: On this date an interim stock market bottom may have occurred.)
Is the US stock market worried about a “Thucydides Trap” and its implications for US policy? We think the answer is yes (hat tip to Jason Trennert for raising the question) and that it may explain why a trillion dollars in market cap can get wiped out quickly and why (as Strategas’s Don Rissmiller has noted) all of the “discounted benefit of the tax cuts ($800 billion fiscal stimulus) got erased by $37 billion in tariffs.”
Let’s tackle information asymmetries, Trump, and Thucydides.
We begin this multi-part commentary with a recommendation of Graham Allison’s book. We suggest that it go immediately to the top of your reading pile. The title is Destined For War: Can America and China Escape Thucydides’s Trap? (See https://www.amazon.com/Destined-War-America-Escape-Thucydidess-ebook/dp/B01IAS9FZY.) For the government and academic credentials of Graham Allison see: https://www.hks.harvard.edu/faculty/graham-allison. For an overview of the Belfer Center at the Harvard Kennedy School, see: https://www.belfercenter.org.
Graham Allison coined the term Thucydides Trap (T-Trap) to describe the reactions between world powers and how one of them may engage in an action in response to how it perceives the other (information asymmetry at work). Over and over in the history of the world, a rising power challenges a a dominant power, creating fault lines of stress and competition between the two. Allison provides a detailed historical log of 16 such major events in the last 500 years. He documents how 12 of the 16 ended in war.
As investment professionals, we must immediately note that in the first four of Allison’s 16 events (Spain versus Portugal, 15th century; three rounds of the Hapsburg Empire’s demise) there was no stock market. In the other 12 examples there were bourses. Amsterdam’s was the first one, trading shares of the Dutch East India Company in 1602. Over the following four centuries, other stock markets came into existence. In each occurrence of a T-Trap scenario, there was a serious market reaction. There are no exceptions. War or a perceived risk of war moves stock market prices.
We believe that the Datatrek warning about information asymmetries is correct and that Allison’s concept of the T-Trap is applicable in many forms today, although Allison focuses primarily on the geopolitical realm. Here is Allison as he argues that the US-China relationship is developing as the 17th T-Trap case study. (Remember, he has 500 years of history on his side of the argument.)
“In the seventeenth case, an irresistible rising China is on course to collide with an immovable America. Both Xi Jinping and Donald Trump promise to make their countries ‘great again’. But unless China is willing to moderate its ambitions, or Washington can agree to share primacy in the Pacific, a trade conflict, cyberattack, or accident at sea could be the spark that ignites a major war.”
Note that the moving agendas in relations between North and South Korea, as well as between Japan and the US, are also parts of the huge global realignment underway. All these countries but North Korea have major stock markets.
When we say moving agendas, we need to always be thinking about asymmetric information. Here is an example of what we didn’t know and the North Koreans did know: it may explain Kim’s motivation.
Source: NightWatch. “On 25 April, the South China Morning Post reported that North Korea’s mountain nuclear test site has collapsed. Two separate groups of Chinese geophysical scientists studying the mountain have reached the same conclusion. A research team from the University of Science and Technology of China (USTC) in Hefei concluded that the collapse occurred because of the detonation last September of North Korea’s thermal nuclear warhead in a tunnel about 700 meters (2,296 feet) below the mountain’s peak. According to an analysis posted to the team’s website, the 100-kiloton explosion on 3 September vaporized surrounding rocks and opened a chasm that was up to 200 meters (656 feet) in diameter. A large section of the mountain’s ridge slipped into the pocket created by the blast. The explosion turned the mountain into fragile fragments, the researchers wrote. The USTC team plans to publish its findings in the Geophysical Research Letters of the American Geophysical Union, according to the Post article. Another research team at the Jilin Earthquake Agency of the China Earthquake Administration in Changchun reached similar conclusions to the USTC team. It concluded that the fracture created a “chimney” that could allow radioactive fallout from the blast zone to rise into the air. This team published its findings in the 16 March edition of Geophysical Research Letters of the American Geophysical Union.”
A specific domestic stock market asymmetry is found in the Amazon-Trump squabble. Remember that Jeff Bezos owns the Washington Post and that Trump doesn’t like anyone who is critical of him. Also note that more people use Amazon and vote for it with their pocketbooks every day than voted for Trump (or for Clinton, if that matters). Amazon outpolls Trump with real money bets by its customers.
Here is information asymmetry applied to the stock market. If you knew that President Trump would soon be picking a Twitter fight with Bezos and Amazon, would you front-run the news (or tweet) and sell Amazon? That’s what went down once their fight started. We’ve seen many other examples, too, where Washington politics made news and dramatically changed market prices.
Here’s another info-asymmetry example: If you had had early warning signs that the new tax law bill would have a component that was detrimental to MLPs, would you have bought, held, or sold MLPs? Clearly, the tax bill hurt certain MLPs.
In an era of tariffs, barriers, protectionism, and trade wars, doesn’t this T-Trap scenario (with its component of asymmetrical information) apply to every item in the commercial arena? Isn’t that one of the outcomes of protectionism? Would you buy, sell, or hold if you knew, before a tariff announcement, that your item was going to be mentioned? Remember the trade negotiation with China is underway, right now!
The T-Trap has nothing to do directly with stock markets; it is about lessons from history. It is about imperfect information leading to mistakes and mismanagement of geopolitics. And it is about the assumptions used and decisions taken by nation states and their leaders. What Graham Allison says about the T-Trap and why it is important is best summed up in a remark often (but perhaps incorrectly – see https://quoteinvestigator.com/2014/01/12/history-rhymes) attributed to Mark Twain: “History never repeats itself, but it rhymes.”
Stumbling into a Thucydides’ Trap results in painful time of reckoning — a “day of wrath, that day which will reduce the world to ashes,” if you will permit me an old Latin phrase that comes to mind (Dies irae, dies illa Solvet saeclum in favilla…).
There is no evidence that corporate shares existed and traded in the ancient Greece of the Athenian historian Thucydides. There is some evidence that deals occurred with partnerships and similar organizations. The Greek stock market is modern, not ancient.
There is, however, evidence of using money to settle disputes without war and of encouraging commerce over war. There is also evidence that during 30 years of peace following a treaty agreement among the Greek city states, dispute resolution was handled according to agreed-upon procedures. Thucydides includes such references in his chronicle, The Peloponnesian War.
The Delphic Oracle was an early version of an international court. We might think of it as a dispute-resolution system among the Greek city states, playing a role not unlike that of the World Trade Organization today. Early Greece offers a lesson for our trade and tariff disputants. There are benefits of peace over war, as Thucydides carefully chronicles. But, as in ancient times, the benefits of peace are now being placed at risk. (We encourage readers to examine the history of Pythia, the high priestess of the Temple of Apollo.)
Thucydides was not the first historian to chronicle ancient times. But he was the first who did so in human terms. Throughout The Peloponnesian War (I’m using the Martin Hammond translation) Thucydides avoids references to “the gods.” Thucydides wrote about man’s behavior instead. He left the Greek gods out of the story in order to show how people were, how they behaved and made decisions. He quoted them carefully.
In our multipart series we will talk about T-Traps and trade (although we have hit that one hard already). And we will discuss money (gold). We will try to focus on victory versus defeat. And we will offer investment positioning that may have T-Trap conceptual support for its rationale.
Let me segue to some excerpts from Thucydides. Also, please think about our T-Trap theme in the context of today’s world and in the particular context of US-China relations. Try to imagine today’s bilateral discussions reported by Thucydides with non-Greek names like Trump or Xi or Abe or Navarro or Bolton or Kudlow or Mnuchin as replacements for the leaders of Corinth, Sparta, and Athens. Thucydides dealt with Greek city states, but the context today is nation states.
My takeaway is that 2500 years later very little has changed, and history has been proven to rhyme.
Let’s go back 2500 years to an assembly in Sparta. Greek city state allies of the Spartans have gathered for a meeting. Thucydides quotes a speech by a leader from Corinth:
“Spartans, the trust you place in your own constitution and society makes you less trusting of others when we have something to say to you…. Many times we have warned you of the harm we anticipated from the Athenians…. The time is past for debating whether or not there is aggression against us: The question is how to resist it.”
There are Athenians in the assembly who happen to be in Sparta on business. They speak up:
“Our delegation was not sent here to engage in dispute with your allies, but on a separate mission from Athens. Nevertheless we are aware of considerable outcry against us, and we come before you now… to ensure that you are not too readily influenced by your allies into making a wrong decision on matters of great importance.”
After extensive debate involving many in the assembly, the Spartans clear everyone else away and meet among themselves. Many want war at once. Their king, Archidamus, displays patience and experience. He argues that Sparta is not ready for war:
“Spartans, I am old enough myself to be experienced in many wars, and I see some of you here the same age: None of them will share the longing for war felt by most who have never known the reality. Our navy? We are inferior. Our finances? Here we are more deficient. My advice is that we should not yet take up arms. We should look to acquire further allies… we can supplement our naval resources… let us first see to our finances…. We are not schooled in the useless over-intelligence which can make a brilliant verbal attack on the enemies’ plan but fail to match it in consequent action…. It is our principle to make practical plans on the assumption of an intelligent enemy, and not let our hopes reside in the likelihood of his own mistakes, but in the security of our own precautions.”
One of the five magistrates of Sparta (who collectively have more power than the king) takes the other side and calls on the Spartans to vote for immediate war. The resolution to go to war against Athens is deemed the majority view. Thucydides summarizes:
“This resolution of the Spartan Assembly, the treaty [with Athens and other city states], which had been broken [by Athens] was made in the fourteenth year of the duration of the Thirty Years Treaty.”
Thucydides’ analysis is critically important:
“In voting for war on the grounds of breach of the treaty the Spartans were not so much influenced by their allies as by their fear of increasing Athenian power.”
One element of T-Trap behavior is fear. Thucydides demonstrates this reality repeatedly.
The other two key elements are state interests (what is in the interests of the states and of their leaders?) and honor. “National interests are plain enough,” says Graham Allison. “The survival of the state and its sovereignty in making decisions in its domain free from coercion from others are standard fare in discussion of national security.” Allison warns about maintaining “objectivity” and about the flaws of emotional behavior and acting on misperceptions.
The last pillar is honor. Allison notes: “To many modern ears the word sounds pretentious. But Thucydides’ concept encompasses what we now think of as a state’s sense of itself, its convictions about the recognition and respect it is due, and its pride.” Wow – the danger of appealing to pride as a political motivator.
Fear, interests, honor. Those are the operative three prongs of T-Traps.
Allison concludes that, “Ultimately, the leaders of Athens and Sparta were overwhelmed by their own domestic politics. Pericles and Archidamus understood the insight about the inherent weakness of the leader.” (Can this insight be applied to a US president? Is it is true for all US presidents?) That weakness, too, is part of the foundation of the T-Trap. We add that not having full information (the risk of asymmetry) exacerbates that weakness.
So are stock markets dealing with the risks of T-Traps? We believe the answer is yes. Is the US-China trade skirmish the beginning of a new cold war? That is the suggestion from BCA Research. Does the skirmish have global implications? Yes, says George Friedman. His book “Flashpoints, The Emerging Crisis in Europe” needs to be read in conjunction with Graham Allison’s.
In the next parts of this commentary we will discuss money and investments when T-Trap risks are rising.
Thucydides - series part 1: http://www.cumber.com/thucydides-part-1/.
Thucydides - series part 2: http://www.cumber.com/thucydides-part-2/.
Thucydides - series part 3: http://www.cumber.com/thucydides-part-3/.
Thucydides - series part 4: http://www.cumber.com/thucydides-part-4/
David Kotok
Chairman & Chief Investment Officer
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