Merlin Weekly Macro: Is NATO really as united as it claims?

Oh to have been a fly on the wall in Washington this week! 32 NATO leaders gathered for the 75ᵗʰ anniversary summit, plus Ukraine, Australia, New Zealand, South Korea, Japan and the European Union: beyond the veneer of spit and polish, the tight choreography and the control of what the media was allowed to see, the dynamics must have been intense, intriguing and fascinating. Like watching a tightrope walker cross a canyon blindfolded, all eyes were fixated on Joe Biden: would he miss his step and fall to his political doom?

Quite why the EU, in the guise of the European Commission President Ursula von der Leyen, was there at all is a mystery: the EU is not a country, nor therefore is it a member; it has no pan-EU armed forces; it has no trans-national foreign policy; no NATO member sends its civil service head as the official delegate; every country in the EU, bar Austria, Cyprus, Ireland and Malta—who need no representation because they are officially neutral, is individually a member of NATO and already present in their own capacity and with a mandate; what is the point?

A study in political mortality; a month in the life of the Fab Four (no, not the Beatles)

As a preface, just think what has happened in the very short four weeks since we wrote about the Normandy 80ᵗʰ anniversary commemorations. We analysed the tensions, trials and tribulations behind that photograph of the four western leaders (‘three and a hanger-on’) on Omaha Beach. Sunak had already bailed before the camera went click and today he and his proxy David Cameron are both gone. Biden, after his disastrous head-to-head debate with Trump, effectively gone (even his own team insist so: self-interestedly saying his mind has gone, so should he be; and if he doesn’t go now he’ll be gone on November 6ᵗʰ; he dropped a clanger introducing Zelensky as ‘President Putin’ in the closing speech at NATO, briefly reducing Zelensky to a fit of stifled giggles; he followed at a press interview by referring to his deputy Kamala Harris as ‘Vice President Trump’). Macron, losing in the game of unintended consequences with his peremptory, unforced and unnecessary snap election, is politically self-neutered. Only Germany’s Olaf Scholz remains relatively unscathed. Talk about a bruising month.

Zelensky left wanting more: a familiar refrain

Top of the agenda? Ukraine. How could it not be. The tireless President Zelensky leaves another international forum half-satisfied. The F-16 jets promised more than a year ago are now ‘on their way’ for which he is deeply grateful; he is the recipient of a new 10-year security treaty with the US, already revealed last month at the G7; the UK commits to £3bn a year and will send him more shells and missiles; he has many fine words from most quarters promising him ‘whatever it takes’, knowing full well that ‘whatever it takes’ too often is diplomatic code for either ‘whatever we choose to provide you with’, or ‘whatever it takes to get you to negotiate with Putin’.

On the other hand, like the Gordian Knot, his path to NATO membership never unravels: yet again he has been fobbed off with platitudes and promises of ‘irreversible commitment to membership’, yet with no time-frame but pre-conditions aplenty; in reality, faced with obstacles in its way from the US and Germany, Ukraine is not much further down the path to membership than it was when it became a ‘Partner for Peace’ (how sick a joke that now appears) three decades ago. Further, the €100bn aid plan agreed by the EU under NATO auspices earlier this year has been watered down to €40bn. He is still in the war but remains far short of the resources to win it outright; by force of circumstance his is a defensive campaign. That outgoing Secretary General Jens Stoltenberg needed to clarify ‘this is not charity’ betrays just how prevalent the unspoken mood is that everyone is doing Zelensky a favour.

United, unbowed and unsullied. Not quite

Ahead of the Summit, it was the Polish foreign minister, Radoslav Sikorski, who was surfing the media airwaves banging the drum that NATO is united: ‘more united than it has ever been’. Similar to Stoltenberg’s ‘not charity’ statement, that the unity theme needed saying at all reveals much. He declared also that Putin has failed in his strategy to ‘buy members off’. The reality on both counts is less absolute.

If the public line on Ukraine is one of studied but qualified unity, the same cannot be said for how to deal with China. Ask 32 NATO members (38 if the guests are included) and you’ll get 38 different answers (many, entirely preoccupied with Russia, have no time to care about China). Xi Jinping will be quite happy with that. The subject of Israel, like Ukraine officially a Major Non-NATO Ally, a status which assures military support, is also shot through with differing opinions.

It is correct that NATO has made significant progress in the past three years since the Afghan debacle in re-establishing its mutually protectionist sense of purpose and persuading members to meet the target financial commitment. In 2024, according to NATO’s own June estimates, it is likely that 23 of the 32 member states will meet the requirement to spend 2% of GDP on defence; a decade ago it was three countries; five years ago, seven; last year 10. But successfully to deter those who would do us harm or threaten our security, such is the state of most western defence capabilities after three decades either of wilful neglect or deliberate run-down, especially in Europe, independent experts say a figure closer to 5% of GDP is required, urgently, unanimously and for the foreseeable future. It must therefore have been deeply frustrating for NATO and embarrassing for Germany that this week the understandably angry German defence minister, Boris Pistorius, was forced to accept a real-terms cut in German defence spending. Readers of these columns will remember last winter when a German court declared the Federal Budget illegal and in the absence of any GDP growth Scholz was forced to find billions of euros of public expenditure savings: the commitment to the €100bn defence catch-up programme is one of the casualties.

As the leaders disperse amid all the warnings of the need to stump up even more cash for security, all the main players are painfully aware of the extent to which they are hobbled by their national economic and financial constraints: Germany’s strict deficit and debt laws define the legality of the national budget (see above); the US (still with its debt ceiling unresolved), the UK, Japan, France and Italy are all heavily indebted (debt/GDP >100%) and with significant and enduring government deficits. Poland, on the other hand, on the front line with Russia and with the wiggle room of only 50% debt/GDP, has made a positive decision to double the size of its armed forces and is spending 4% of GDP on defence. The Baltic States are expanding defence spending too and some have reintroduced conscription. But the fact is, the further back in Europe from the front line and the direct threat of invasion, the more difficult or less committed are the policy conversations about defence and the need to confront really hard choices.

Defence: you get what you pay for

Look at defence like house insurance: you can buy a cheap policy or pay a high premium for an expensive one; but if your house burns down, don’t complain afterwards if the cover was inadequate. In defence, the premiums are to ensure that in a game of lethal blind man’s bluff with your opponents, nobody can set the house on fire in the first place, or that if they do, you have the ability quickly to put the flames out. Within an economic framework of finite resources it is a political choice. But to mix analogies, unlike playing games, in warfare second place confers no podium position with a silver medal, a bunch of flowers and a teddy bear for comfort: defeat means certain humiliation, probable subjugation and possibly even worse; how much will you and should you pay to avoid that?

Hungary, Turkey and Slovakia: NATO’s snakes in the grass

As for Putin’s strategy to divide and conquer, whatever Sikorski’s protestations to the contrary about its lack of success, NATO heads are frustrated that at least three countries among its membership are in active friendly dialogue with Putin, leaving aside others who might hold compromising thoughts of future cooperation with him: those three are Hungary, Turkey and Slovakia (represented in Washington this week by the Slovakian president in the absence of prime minister Fico still recovering from the assassination attempt against him a couple of months ago). Notwithstanding that Putin personally is on the international sanctions list and there is a warrant for his arrest for war crimes from the International Criminal Court, in the past week Putin has met separately with NATO members Viktor Orban of Hungary and Recep Erdogan from Turkey.

Not only is Hungary a NATO member, but it also currently holds the revolving presidency of the EU Council for the six months to 31 December; given Hungary is a permanent inhabitant of the EU’s official Naughty Step, this is a cringeworthy period that Brussels is powerless to avoid and must simply endure. Orban insists that his whistlestop talks with Putin, Xi Jinping and Zelensky (Zelensky and Orban together were photographed in a portrait of studied frostiness after Orban told the Ukrainian to sue for peace) are a constructive attempt to keep communication channels open. His critics are sceptical: if not a vassal, Orban is regarded as a Putin sympathiser and supporter, and his ongoing membership of both NATO and the EU is difficult to fathom.

Equally frustrating to NATO is the mercurial Turkish leader Erdogan. Turkey is NATO’s buttress on its key, strategically highly sensitive south-eastern flank. Turkey owns the Bosphorus, the sole shipping channel from the Mediterranean to the Black Sea, home to Russia’s only temperate, deep-water naval installations in the western hemisphere, located in The Crimea, the Sea of Azov and Novorossiysk on the eastern shore. This week, at the Shanghai Cooperation Organisation summit in Kazakhstan attended also by General Secretary Xi, reported by the independent Middle East news agency AL-MONITOR, Erdogan reaffirmed his economic, diplomatic and military ties with his ‘dear friend’ Putin as the two countries consider a new bilateral approach to finding a solution in Syria (where Ankara and Moscow support opposing sides in the long-running conflict). As to not ‘buying off’ a NATO member? Surely a case of semantics. If not ‘buying off’, Russia certainly has economic leverage: AL MONITOR reckons Putin supplies half of all Turkey’s oil; last year the two countries enjoyed $62bn of mutual trade. However, no stranger to the reality of global geopolitical pressure especially from the US, and despite Turkey never having been a party to the western sanctions regime in respect of Ukraine, Erdogan has clamped down on western companies who have been using Turkey as a covert route to continue trading with Russia in goods that are covered by sanctions. (There is Turkish history of flakiness with NATO going back several years when Erdogan bought several batches of S-400 air defence missile systems from Putin; deeply perturbed, the US embargoed the sale of any of the new F-35 stealth fighters to Turkey to prevent the Russians gaining access to NATO’s 5ᵗʰ Generation Combat Aircraft technology secrets through this insecure route).

Russian gourmet dining at the UN: Chicken Kiev

NATO will also have been all too conscious that Putin is far from friendless elsewhere too. Putin’s relationship with Xi is well established: they are friends and partners. Not only has Putin been in Kazakhstan this week, and Vietnam and North Korea in June, a few days ago he also entertained India’s Narendra Modi in Moscow, greeting him with warm embraces and investing him with baubles, a visit which has led to enhanced trade ties.

And in a demonstration of the supreme impotence of the United Nations to act against Russia, it seems barely credible but is absolutely true, Russia currently holds the revolving chair of the UN Security Council and this week at an official dinner, even though personally absent and while NATO’s members were in conference in Washington, as a deliberate insult Putin ensured that the menu featured Chicken Kiev. He must have been sitting at home laughing himself stupid.

NATO’s eminence grise: The Donald

But the lumbering, grinning elephant in the room, casting an enormous shadow over the entire proceedings was the man who was not even there: Donald Trump. Morbidly obsessed with dissecting every movement, gesture, blink and word of Joe Biden’s to see whether he has the capacity (in all senses: physical, mental, political) to stay the course and win the election, there was not one delegate who was not weighing up the future for the Alliance and the world order if, in six months’ time, Trump is president again.

Trump is a nationalist. A typical US businessman, he sees relationships as counterparties rather than partnerships. He resents counterparties who fail to honour their obligations, leaving all the heavy lifting to be done by the US. He is highly critical of NATO. He deeply resents those who not only fail to pay their dues but who also show disrespect to him or the US. He is outspoken and intemperate about the consequences (‘Russia can invade who the hell it wants if those people don’t pay’). He regards Ukraine as a ‘European problem’; his own solution is no more US funding for Zelensky and to do a deal with Putin. His relationship with Putin remains a riddle lost in an enigma.

On the other hand, he is no fool: he fully understands the concept and benefit of NATO. His beef is with its backsliding members, a widely shared view in the US. His antipathy was every bit as vehement both before 2016 and in his presidency during which he famously lined up all NATO’s European delinquents and publicly delivered his Grand Remonstration to them; but he did not blow NATO up. Faced with the increasing threats from China and others, the US needs global allies; it is neither in Trump’s nor America’s interest to destroy NATO were he to secure the White House in November.

That is not to say there will not be many potentially highly corrosive challenges, exchanges and rows along the way. The scenario in which Trump takes the US out of NATO is one in which he feels compelled to leave: the ingratitude is such that, to the devil with it, he’s off (he has already raised the stakes by insisting that NATO qualifying spend should be a minimum 3% of GDP and he is demanding reparations from NATO members who have in his view left the US impoverished supporting Ukraine). While not impossible, the likelihood of unilaterally walking away as a matter of deliberate strategic policy is small and his military would strongly resist such a move. It is no understatement to say the consequences of a US departure from NATO would be catastrophic.

NATO remains heavily reliant on the US for the foreseeable future. It is not Trump-proof. This is precisely why Mark Rutte, Holland’s former prime minister, was appointed to the post of Secretary General: he has a history of being able to deal with Trump, to reason with him and mollify him while also being robust. Nevertheless, all Rutte’s considerable diplomatic charm and mettle will be fully tested.

Starmer: ‘do as I say, not as I do’

Thrown straight in at the deep end, our new Prime Minister, Sir Keir Starmer, made his international debut at the NATO summit barely six days after assuming office. Many fellow heads of government, including Biden, had never met him before (it is not unfair that in his addled state, having only just established that ‘Rashi Sanook’ was in fact prime minister Rishi Sunak, Joe Biden might be forgiven for being confused as to how a fourth British PM, this one with a first name sounding like a South Korean car manufacturer, has turned up during his short presidency; don’t worry, Joe, old bean, many of us living here in the UK are equally confused).

Parachuting on to very thin ice to plant his pennant among already seasoned NATO campaigners and camp followers, our new kid on the block wasted no time after landing before lecturing his new-found allies about the need for every one of them to spend not only 2% of their national GDP on defence, but 2.5%. Brazen in its disingenuousness, it takes chutzpah to do that given where he is coming from. They will be right to be not only indignant but also sceptical.

Indignant at Starmer’s hypocrisy that under his week-long leadership, already the commitment to the UK’s own 2.5% target has been diluted from his predecessor’s ‘by 2030’ date-stamped aiming point to Starmer’s self-imposed constraint of only when ‘conditions allow’. The Armed Forces minister, Luke Pollard, blew the gaff: he said this week in an interview that extra defence spending is conditional on economic growth. Therefore, translating political code into plain English, Starmer’s Washington audience may infer that defence might be important but it is not his key priority in government: he will not sacrifice other areas of public spending to bolster defence.

They are right also to be sceptical about his commitment to defence until he proves otherwise: the UK has form. Starmer’s broad manifesto pledges on defence (‘unshakeable commitment to NATO’, maintaining Trident, improving service pay and conditions, strategic approach to procurement) lack the substance of a full defence review to be completed in 2025 which will define our defensive and offensive capability under the new government. Early days yet, but Starmer’s intention, with the full agreement of Foreign Secretary David Lammy and Defence Secretary John Healy, is to pool resources with France and Germany (Starmer and Scholz signed an MOU this week); a case of reintegration with the EU by the back door dressed up as allied cooperation? Or ‘we’ll supply the military brain; you supply the cash and the brawn; we can’t do both’? Time will tell. As we have said before, the political calculation is that while Zelensky holds the fort, messrs Putin, Xi et al all politely wait while the Treasury does its sums and the MoD conducts yet another strategic defence review both in their own sweet time.

We wait to be proved wrong but all the political smoke signals point towards a feeling of déjà vu: as Chancellor George Osborne did in 2010 when the Coalition government took office, in 2024/5 it will be Rachel Reeves who defines the financial terms of reference for the defence review and determines what defence forces we are allowed, not the strategic threats we face which dictate what we need to keep ourselves secure.

They say History allows you to learn from your mistakes; time will tell whether Starmer, Reeves, Lammy and Healy were awake during the lessons.

The Investment Perspective

Apart from the obvious read-across to the defence contractors, most of the issues we have discussed here are difficult to quantify and to apply specifically to broader asset classes. That does not make them irrelevant.

The geopolitical tensions expressed in such summits as NATO, the G7, Davos etc are more usually reflected in what is referred to as the ‘risk premium’, particularly in bond markets, which is when investors ask themselves what return they would normally expect from a given investment and then consider how much additional return is needed to compensate them for the additional risk they see that investment as having. Less a precise calculation, mostly the risk premium is a finger-in-the-air assessment of the additional perceived risks which either already exist or may in the future. Ephemeral by nature, it inevitably contributes to volatility.

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.