Merlin Weekly Macro: A threat to the rules-based order

This week witnessed two significant events. Their common theme is conflict. First, NATO celebrated the 75ᵗʰ anniversary of its founding. Second, in the UK, six hundred lawyers including three former Supreme Court judges wrote an open letter to the government demanding that all military aid to Israel be suspended.

A rules-based order?

A civilised society, we live in a rules-based order. It is governed by internationally agreed treaties, conventions and protocols mandated and enforced through global representative and jurisdictional bodies such as the United Nations, the International Court of Justice, the International Criminal Court and others. The value of those arbitration and enforcement institutions as the guardians of common values is tested when countries or non-state agencies decide to take action that is clearly in violation of the rules; they show their mettle, or demonstrate the limits of their influence, when battle is joined between opposing teams, when the referee is wilfully ignored and, save that it is often vocal, when one cannot be certain whose side the crowd is on. Today, the rules-based order is clearly being challenged. The lightning rods and test cases are Ukraine and Israel.

Existential threats to Ukraine…

Ukraine, a country whose sovereignty was supposed to have been assured by treaty (in this case the 1994 Budapest Memorandum between Ukraine, Russia, the United States and the United Kingdom) has clearly and repeatedly been violated since 2014 by Russia, including its full-scale invasion in 2022. How can it be that in the third year of war a large sovereign, democratic European country, on the path to both EU and NATO accession, is being wilfully destroyed and dismembered by its neighbour who is both a co-signatory to the Budapest Memorandum and a permanent member of the United Nations Security Council? The conflict for Ukraine is existential: if it loses, it will literally cease to exist, certainly in the form it was in either before 2014 when the Crimea was annexed or 2022 when the whole country was invaded. As evidenced in the UN votes condemning Russia, through abstentions or votes against, countries amounting to half the world’s population have effectively determined either that they disagree or they are not taking sides, it is not their problem.

And Israel

Israel too faces an existential threat. Led principally by Iran and actively aided and abetted by its non-state acolytes and proxies (e.g. Hamas, Hezbollah, the Houthis and others), a significant proportion of the population of the Middle East wants nothing less than the obliteration of the State of Israel from the map. In our October 13ᵗʰ 2023 column, immediately after the Hamas attack on the Jewish Kibbutzim, we referred to a prescient article in The Times by William Hague, former UK Foreign Secretary; we wrote: “he [Hague] warns that as Israel prepares a massive military response in Gaza with the explicit aim of destroying Hamas, it needs to beware falling into the trap laid for it by the organisation and its Iranian sponsors. In deliberately committing genocidal atrocities against civilians in the Jewish kibbutz settlements on the Gaza perimeter, with the knowledge (more accurately, the cynical intent) that hundreds of Palestinian civilians will be killed and injured in return, Hamas is trying to provoke a full-blooded response by Israel, to stoke up anti-Israeli sentiment worldwide.”

Hague was spot on: Israel has fallen head-first into the trap. Almost friendless, it now finds itself being arraigned formally by South Africa before the International Court of Justice on allegations of genocide in the Gaza Strip; the most recent vote in the United Nations for an immediate ceasefire saw a significant shift of ground among Israel’s erstwhile supporters with the UK moving from abstention to voting for the resolution and the US adopting a firmer line in the face of international criticism and dropping its previous veto and abstaining instead (as we go to press, following the fatal Israeli air strike on the World Central Kitchen aid convoy this week, Joe Biden’s stance has hardened and he has successfully insisted that new humanitarian aid corridors with enforced protections are opened to Gaza); in the UK, His Majesty’s Government is being challenged directly by leading lawyers and legal academics that the UK maintaining military supplies to Israel (as it has a duty to do given Israel is officially a Major Non-NATO Ally, MNNA, which affords it NATO military aid but no guaranteed protection) is breaching international humanitarian law.

“We judge our friends by higher standards”

Lord Sumption, a former judge in the Supreme Court, was one of those signatories. On the Radio 4 Today Programme, arguing both the legal and humanitarian angles, the implication of his interview summary is that ‘we judge our friends (and he claimed to be “a potential friend of Israel”) by higher standards than our enemies’, even in cases of self-defence and when the threat is possibly terminal.

The democracies are expected to play by the rules and obey the referee even if the opposition has no respect for either. In the wake of such bloodshed, such a stance is entirely understandable in upholding western values. However, there should be no surprise that an asymmetric application of legal standards is likely to produce an equally asymmetric real-world outcome. At what point can knowledge of those international laws and institutions be exploited cynically by protagonists with malign intent against those expected to abide by them?

Lacking willpower and leverage

NATO and the UN have learned that they have little if any legal leverage at all over either Russia or Iran and its affiliates. Russia remains a fully functioning permanent member of the UN Security Council, still exercising its powers of veto safe in the knowledge that there is no instrument in the UN Charter under which Moscow can be expelled. Economic and legal sanctions have proved utterly ineffective in either changing Russia’s behaviour or limiting its financial and military capacity to wage war against Ukraine. Similarly, Iran has also proved to be impervious to sanctions: even if there has been an economic impact, sanctions have singularly failed to effect behavioural change in the regime. Tehran duped the West when it cynically signed the Joint Comprehensive Plan of Action (JCPOA), otherwise known as the Iranian Nuclear Containment Agreement, with no intention of compliance and subversively continuing with its programme of producing enriched weapons-grade uranium.

While Russia tackles its targets head-on, Iran’s approach is oblique, preferring to use a wide network of affiliates to deliver its strategy even if it runs the risk of losing control over them. Not wanting to be drawn into direct conflict with either (though the US and the UK have taken offensive action in the Red Sea and the Gulf against the Houthis), military support for Ukraine and Israel, both with the same status of MNNA, is demonstrably conditional. What is important in the wider context is what signals such actions as the actions being forced on the UK government, the US withholding military funding to Ukraine and Israel, and the UN votes edicts against Israel, send to the countries and agencies included in former President Bush and current President Biden’s Axis of Evil about how far they can go before the West not only says “Enough!” but is actually prepared to take hard action to confront them.

NATO at 75: creaking into old age but holding together

Which brings us to NATO’s three-quarter century celebration this week. Delivered of Donald Trump’s recent remonstrance that the Russians can go ahead and “invade who the hell they want” among NATO members who have failed to pay their dues, there have been two beneficial effects. First, European members of the Alliance have woken up to the possibility that America under Trump might not ride to the rescue in the event of an attack and are taking the threat as more than a joke; second, through NATO Secretary General Jens Stoltenberg’s tireless shepherding and goading, at least temporarily the EU members of the Alliance have seemingly stepped back from the brink of wanting a separate, rival defence force; the tentative agreement for a $100bn security package for the long-term benefit of Ukraine strictly under NATO auspices helps keep the Alliance together and focused at a time when friction and fracture were once more becoming apparent. The Daily Telegraph editorial on the subject reminded us of General Ismay when appointed NATO’s first chief and his succinct and blunt summary of the purpose of NATO when it was created in 1949: “it’s there to keep the Americans in, the Russians out and the Germans down”. Germany is clearly no threat; as regards the Americans and the Russians, the goal today is every bit as relevant as it was 75 years ago; the current imperative has been to persuade isolationist Republicans of their international responsibilities and to stop a large proportion of the Alliance membership backsliding and assuming the Americans will unconditionally pick up the tab despite obvious attempts to disintermediate the US.

However, while there has been progress in keeping NATO intact and dragging the membership towards the minimum spend of 2% of national GDP on defence (18 of the 32 members are expected to meet the minimum standard in 2024), that 2% was set when the threat from Russia, China, Iran, North Korea and others was considerably lower than today. To avert the risk of greater conflict, what is important is that our opponents understand our red lines and that if crossed, there will be a hard military response. Instilling that fear of there being all hell to pay requires members to be prepared to do what Stoltenberg was urging last year, to spend “significantly more than 2% of GDP” as a credible deterrent. For the record, the average spend at the height of the Cold War was 4%. In 2023 at the Vilnius summit, the membership baulked; will it do it again this summer? We’ll soon see.

For investors: difficult but important

Does all this matter to investors? Certainly. As Merlin Investment Director Alastair Irvine said in his “War and Peace” analysis of global geopolitics in early February, the world is its least stable and facing its greatest threats in at least two generations; markets struggle to contextualise this, particularly in the overarching approach to assessing risk. But however difficult the problem, placing it to one side to concentrate on inflation, interest rates, growth, technology and climate change does not make it go away. The continuing US government spending row and the debt ceiling impasse in Congress causing the $95bn military and humanitarian aid packages for Ukraine and Israel to be blocked have immediate life and death consequences and longer-term geopolitical implications. Here in the UK, the continuing failure to confront hard choices on public spending were behind Jeremy Hunt backtracking in the Budget on the earlier commitment under Boris Johnson to raise defence spending to 2.5% of GDP by the end of the decade; now the stance is reduced to “we’ll do that if economic conditions allow”. The choices only become starker (actually, the lack of choice between radical reform and doing nothing becomes even more obvious) when also confronted by the significant competitive threats and the eyewatering costs arising from meeting the commitments to carbon net-zero.

As the providers of capital, investors and markets are no mere bystanders. In an increasingly passive investment environment, they have an important active role to play. The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.

Postscript. Lord Cameron: more than a historical footnote.

Foreign Secretary David Cameron heads the ‘immediate Israeli ceasefire’ lobby in government and was instrumental in the UK changing its UN vote from abstention to being in favour of the motion; his stance is at odds with that of Rishi Sunak who, battered by both sides of the argument, has lost his authority. Pertinent to both the foreign policy and defence aspects of this article, Cameron has form going back to his days as Prime Minister. Let us refresh your memories.

In 2011 at the dawn of the Arab Spring, Cameron, Nicholas Sarkozy of France and Barak Obama and Hilary Clinton collectively decided, opportunistically after the first riots broke out in Tunis, that actively destabilising the entire North African coastline east of Algeria was a constructive foreign policy. The action included removing Colonel Gaddafi and bombing every major town in Tripolitania and Cyrenaica without one iota of an idea whom they were backing and to what end. Having precipitously and rashly sold our aircraft carriers and all their Harriers in Cameron’s (more accurately Chancellor George Osborne’s) misguided and misnamed 2010 Strategic Defence Review, or SDR, (other than cutting the defence budget there was no strategy), we were initially reduced to bombing Libya from Norfolk, one aircraft at a time, immediately showing our foes just how deficient our newly hollowed-out defence capability was (as also pointed out in the press at the time, the Type 42 Destroyer, HMS Liverpool, our sole naval asset in the area diverted to the Gulf of Sirte in the ironically-named Operation Unified Protector, was already on her way home to be scrapped as a further part of the Navy’s share of the defence cuts). Even if nominally in a state of ceasefire after the ensuing civil war, Libya remains politically unstable more than a decade later. Its lawlessness has been exploited by Russia’s GRU and or/Wagner groups as a primary conduit through which to traffic migrants across the Mediterranean into southern Europe with the intent of creating political dislocation.

In the wake of the Iraq “Dodgy Dossier” scandal and the aforementioned SDR, parliament had no appetite for any conflict that involved boots on the ground in Libya to help contain the vacuum created by the western powers; combined with the recklessness of the Libyan policy and Obama’s equally misguided interventions in Egypt, with the removal of President Mubarak undermining a cornerstone western ally in one of the most geopolitically sensitive regions on earth, Cameron suffered a major parliamentary defeat at home. Westminster refused to commit troops to Syria where they really were needed after President Assad crossed a supposed red line by using chemical weapons against civilians. The consequences were significant.

It was on the back of this parliamentary defeat for regime change that US support for a direct Syrian intervention evaporated in Washington too. Iran and Russia filled the vacuum in Syria in support of President Assad; with affiliates already established in Pakistan and Afghanistan, the broader regional destabilisation allowed ISIS/L, Daesh, Boko Haram, Al Qaeda and others to coalesce in significant pools of malign influence spanning thousands of miles from Mesopotamia, through the Levant, into Arabia to the Indian Ocean, along most of the North African Coast, all the way down into Sub-Saharan Africa, taking in Mali, Niger, Chad, Nigeria, Somalia and Kenya. The emergence of the radical Islamist Caliphate in the transnational Levant region was eventually defeated in 2018 only after a prolonged and bloody conflict by a US-led “global coalition” mainly comprising Syrian troops and Iranian-backed Syrian and Arab militiamen on the ground, plus coalition and Russian air strikes.

It was the Cameron government which was party to JCPOA, the flawed and failed Iranian nuclear containment treaty; the consequence of failing to prevent Iran pursuing its own strategic agenda is still playing out today only too self-evidently.

It was on Cameron’s watch that Russia violated the Budapest Memorandum when it invaded and annexed the Crimea in 2014. Despite the security assurances enshrined in the Treaty, the response from Washington and London was nugatory.

QED.