2017 Forecast Mid-Year Report Card

Xander Snyder and Allison Fedirka explain the purpose and utility of the GPF report card and discuss why some forecasts were not entirely accurate. Sign up for free updates on topics like this! Go here: hubs.ly/H06mXwR0 TRANSCRIPT: Xander Snyder: Hi and welcome to the Geopolitical Futures podcast. I’m Xander Snyder. I’m an analyst here at Geopolitical Futures and I am joined today by Allison Fedirka, a senior analyst here at Geopolitical Futures. How’s it going Allison? Allison Fedirka: It’s going well Xander, how are you? XS: Doing good. So today we’re going to talk about something that really makes Geopolitical Futures what it is, which is our annual forecast and specifically our mid-year report card on that forecast. So Geopolitical Futures publishes every year a forecast on what events we believe will transpire throughout the year and we also have a long-term forecast so you can understand how those annual forecasts fit into larger trends in the world. And then we evaluate our performance both mid-year and at the end of the year. So Allison, why do this? Why have a report card? AF: So we have two report cards, we’ll have a mid-year report card and a year-end report card and in both cases the purpose is to keep us honest. We need to maintain our intellectual integrity and we have always said that we have a model and that we strictly adhere to it and our forecasts are based on that. Every once in a while, we may not be accurate with our forecasts and this is one way that we can check in, see where the accuracy lies, pat ourselves on the back when we’re right, acknowledge when we’re wrong and then course correct if it’s needed so that our model and our understanding of the world stays consistent, stays accurate and we can make sure our understanding is the correct understanding and developing as needed as the world continues. So we’ll have things that are on track, we’ll have things that are complete, we’ll have things that are not on track at all, we’ll have things that we haven’t foreseen that we probably should have put in our forecast initially but failed to do. So it’s really a comprehensive project that goes through all of our forecasts and tell us where we’re right, where we’re on track and maybe where we need to rethink things and course correct a little bit. XS: Right and we’ll assign a letter grade to each discrete forecast we’ve made, right? ‘A’ is it has come true, ‘B’ is trends are moving in the direction to make it true, ‘C’ is there are no immediate indications that trends are moving in the direction to make the forecast correct, ‘D’ is we got it wrong and ‘F’ is we forecasted just entirely the wrong thing. So this mid-year report card will be published tomorrow and you’ll be able to read the full rationale for all of them as well as a little blurb if you just want to get a high level summary. So one of the things that I really like about these forecasts and the report cards that I think distinguishes Geopolitical Futures’ work more as an analysis than news is the model for publication holds us to statements that we’ve previously made, right? A lot of news sources will publish one thing and then you can kind of just move away from it. But at Geopolitical Futures, we are constantly following events as they develop and we have to always refer back to, well it’s a constant interpretation of what’s happening in the world, but we’ll be referring back to statements we’ve made previously. So it always sort of fits in the context of our model for interpreting world events. And what we’re going to do on this podcast is take you through some of the more significant forecasts that either went our away or didn’t go our way as of now, as of mid-year. So maybe we should start in, well North Korea is on everyone’s minds and that seems to be one of the ones that we struggled with. We didn’t really anticipate North Korea shaking the global geopolitics as much as it had. What do you think contributed to that Allison? AF: So there’s a few different factors, first we should clarify that basically our forecast was that North Korea would continue to develop its nuclear program, that there would be no war and that 2017 would look very similar to 2016 and North Korea would not really occupy a major role in the geopolitical events of the region or even the world at this matter. That’s obviously not the case. So we’ve needed to course correct a little bit, we’ve written some of our analysis and Deep Dives throughout the last two to three months that helps kind of go into that in-depth of where we think things are going now. And one of the main reasons for North Korea is the development with their missiles has changed more than I think we initially anticipated. So the information coming out, the assessment of their military capabilities is very opaque. And the United States now needs to react to the potential threat of a North Korean missile and that is very different from having a North Korea that couldn’t attack the United States. And so a red line has emerged that we did not see coming and that has forced the U.S. to take action and deal with this issue head on as opposed to just kind of placating the situation and calling on China, for whenever there’s a rally or some ruckus going on, calm North Korea down and then walk away and wait for the next round of excitement to begin. I know you have actually done some of our more in-depth work on the actual missiles and weapons systems of North Korea so in terms of like technical things and actual red lines and threats, I think you might be able to kind of add a little bit of where those things come from. XS: Yeah, I mean the first thing you notice when you start to dig into the research that’s been done on really any aspect of North Korea’s military is a lot of experts making best guesses just because this information isn’t publicly available, right? So, I think they’ve just launched what a lot of folks are saying was an ICBM earlier this week on July 4. Before that, experts have been tracking engine tests of different types of rockets that they believe conceivably could’ve been engines for ICBMs as opposed to intermediate-range ballistic missiles and so I mean there’s two aspects of this, right? One is the missile side and one is the warhead side. And there is still confusion, or uncertainty rather, about their missile capability even though they’re claiming now that they have a missile can strike the U.S. Ultimately, it didn’t fly quite that far, right? It flew at a trajectory that was about 45 degrees which made it go higher and not further, so in theory it seems like it can reach a lot further than it actually did but we’re not sure. On the other side is the idea of both miniaturizing and ruggedizing a nuclear warhead that can fit on the end of one of these ballistic missiles. Because on one hand it needs to be small enough and that’s an engineering challenge in and of itself and the next is it needs to be able to withstand re-entry into the atmosphere. Because the way ballistic missiles work is the engine will power them up to the apex and then they follow a parabolic route and they’re just pulled down by gravity. The engine doesn’t need to take them the rest of the way. But that means that they need to go quite high in order to achieve the range that – or hit a faraway target. So there has been – I think experts are saying now that they believe the consensus is that North Korea does have some degree of a miniaturized nuclear warhead. They are still uncertain about the ruggedized aspect of it. But even with that one bit of uncertainty, you have consensus moving towards the idea that they have a miniaturized nuclear weapon and now it seems like they are getting closer to having a ballistic missile that can hit the United States. And Geopolitical Futures has said before that the U.S.’ red line is gonna be North Korea actually getting to a point where they can deliver that nuclear weapon and James Mattis has basically said as much publicly. That we’re not going to let the North get to that point. And we’ve done other podcast episodes and we’ve done a lot of written pieces on North Korea’s conventional military as well – how Seoul plays into the calculations on the peninsula right now and how the U.S. needs to consider that if a war were to break out. But I mean the two-second summary here is when you’re dealing with secretive states like this, there’s only so much information that’s available and so I think as we made this forecast, we’re doing our best to navigate a gray zone and we missed it. AF: Which is a learning experience and as we pay more attention, we get a better sense of how the government will behave as well as patterns of their behavior and imperatives, so that in the future, we will hopefully have a better read and grasp on the situation. Another item that we discussed and we’re slightly surprised with and therefore not as accurate as we would’ve like to have been is Italy. And Italy in this case is not quite as opaque but we did have some surprises there in terms of what we were expecting and what we actually thought would happen. So our forecast with Italy was that the banking crisis will continue and also that it will turn into a political crisis and cause the confrontation of Italy with Germany and the European Union. So one thing that we try to do at Geopolitical Futures is to be precise a little bit more with our language.   It’s very easy to sound smart when you use abstract language without quite specifying what it is that you’re talking about and that was one component that was really important with our Italy forecast in terms of what did we mean by banking crisis, what did we mean by continue. One of the easiest things that you can do in a forecast is just say everything is going to stay the same and the challenge is to say well what’s going to stay the same, what’s going to be different. And Xander, we expected the crisis to continue and that there would be some political crisis and tension with the E.U. and it wasn’t exactly how we had imagined. I know you’ve looked into this and can probably explain a little more of how the situation changed from what we were expecting based on previous behaviors of the other European Union countries dealing with their financial crises with Brussels versus the Italian approach. XS: Well just for a little context, what were the problems and what are the problems that Italy’s banking has been facing? Perhaps the most ominous is the rise in non-performing loans, or NPLs, and all of that basically means is that the borrower has gotten to a point where for whatever reason their business is struggling or they’ve lost their job, their loan payments are greatly delayed or they’ve just stopped making them entirely. And obviously, this is dangerous for banks because they expect to make their money and be repaid and if they start encountering a lot of loans that are not being repaid then you have to start worrying about a liquidity crisis and you know bank runs and all that. So the trend of NPLs in the Italian banking system had been increasing for a number of years. It got to about 18 percent of all loans outstanding in the Italian financial system. And we were expecting that trend to continue, get worse and for Italy to continue struggling implementing any sort of solution to their NPL situation. Since we had watched Greece and Spain and Ireland deal with a similar problem, although in different ways, we thought you know that would be a good rubric for evaluating Italy. Which basically meant that Italy was going to have to work with Germany in some way or another for a large bailout to help recapitalize their financial system, which is essentially what Spain did. And since we believed that Italy has a larger economy than these other countries who have dealt with NPL issues and it has different interests than Germany does, that those interests will clash and there would be no compromise. And this is not exactly what we’ve seen play out. Italy has begun to solve its NPL issue. The NPL ratio is no longer increasing. They’ve kind of topped out over the last year or so and now are slowly starting to decline. Some of Italy’s biggest banks have implemented successful restructuring initiatives, which basically means firing a lot of people and cutting costs and reducing the size of the bank so that they can continue to get to a point where they’re profitable in the future with fewer assets. Italy’s two biggest banks, Unicredit and Intesa Sanpaolo, have both been successful in this regard and they haven’t needed any bailout. So that is what some in economic jargon have come to call the decentralized approach, which just basically means the banks have been able to somewhat successfully solve their own problems. Now it’s not like this with all of Italy’s banks. Monte dei Paschi di Siena, which is I think the third largest Italian bank by assets, had the highest NPL ratio. However, they were able to reach some accommodation with the European Central Bank that allowed them to receive state funding from Italy, not from the ECB but from Italy itself. And there’s another acquisition by Intesa of two smaller banks that the ECB also allowed Italy to provide some state funds for. So the question is, we’re seeing some degree of compromise, does that mean that Italy has essentially been able to get what it wants? And since Italy has been following all of the EU’s rules, it’s hard to tell if one side has really bent to the will of the other, but it has been enough off the mark that we labeled that particular forecast a C and will continue to monitor and see if the solutions that are currently in process that are being implemented are successful. AF: Well that makes sense and I would also take the moment now to just explain the nature of a mid-year report card is that a lot of the information we have to fully judge the accuracy is incomplete. The Italy forecast I think is an excellent example of how we can judge a situation about where we stand now and where we could potentially see the situation going. And where we are in July will obviously be very different than where we are in December, so it will be very interesting six months from now to compare the different grades in progress from some of our forecasts now that may seem way off track or a pipe dream will end up being perhaps, coming to fruition or being more on track now than it was in the past. And Italy is a great example of that, where it’s not exactly what we were expecting but there’s still six months left in the year and we shall see where things take us. Another interesting thing about our forecast would be the I would say the timing of things so sometimes the accuracy of our forecasts tend to not be so much with the actual material or forecast itself but the timing and I know one of the forecasts that is on track but tracking a little bit faster than we were anticipating is one of our items with the U.S. economy in general. Our U.S. economy forecast dealt with both trade and with the potential for a recession and I know Xander that we’ve been observing some signs of recession in the U.S. economy and where that fits in with our forecast. XS: Yeah, so the specific wording of that forecast was the U.S. will not experience a recession in 2017, but will show signs of one by the end of the year. And we’ve seen a couple indications that those signs are already showing themselves. One, the unemployment in the U.S. is as low as it’s been in years. And that might sound good but the question then, is how much better can it get. And when an economy is at full employment and you factor in that the U.S. economy sees a recession every eight to 10 years or so on over average and this is a cycle that repeats itself, usually the best unemployment figures come right before a recession starts because there is just not a lot of room to improve. Another indicator we’ve seen is the VIX metric, which measures global volatility, it is at an all-time low which is a sign that there is some complacency in the market, that people are just very comfortable with where things are and that is also usually something that occurs right before a recession. Another perhaps more immediate indicator that we’ve seen recently was a monetary policy decision by the U.S. Federal Reserve. They’re increasing the federal funds rate by another 25 basis points, which is not particularly remarkable because they’ve been increasing rates since the end of 2015. However, for the first time since the end of the ‘08-‘09 recession, the Federal Reserve will be selling longer-term Treasuries. And this was, when it was buying longer-term Treasuries through a number of programs called Quantitative Easing, it was essentially the Fed’s way of trying to support the market through less conventional means because the Fed will usually attempt to manipulate shorter-term interest rates. So the fact the Fed is now selling off long-term bonds is, well there’s two ways to look at it – one, a sign that the economy looks like it’s doing better, but if you think a couple years down the road, it’s also a sign that the Federal Reserve is recognizing that if it is too in monetary policy, it needs to do it now. And it would want to tighten monetary policy so that it has room to lower it in the future in any sort of contraction. So we’ve seen that. We’ve seen the U.S. yield curve at relatively flat levels compared to the last 10 years which is also often an indicator of a recession coming in between six and 18 months or so. So that’s something that we anticipated that appears to be developing earlier in the year than we were anticipating. AF: But bottom line, still keeping the forecast on track, we do not foresee the recession actually starting this year? XS: Right yeah that was a B. AF: Gotcha. There is also one major component left. We’ll talk a little bit about this and then to wrap I want to include some places where we’ve done quite well with our accuracy. The purpose of this particular podcast is to increase the transparency that we have with our forecast and our grading and our methodology for why we come to the conclusions that we do and acknowledging the areas that would like to explain better for why we were not as accurate as we thought we would be. And the main remaining one left would be Turkey and Iran, which we foresaw a larger role of Turkey in the Syria crisis. We also foresaw a lot of confrontation between Iran and Turkey emerging this year. It also appears to be one of those situations where we’re only halfway through and there’s lots of maneuvering room between now and Dec. 31. And it’s good to recap what we’ve seen so far because that is one of the pillars that we have in our Middle East forecast that is not quite on track and is not happening as fast as we thought it initially would. XS: Right, so what do we think would happen with that forecast Allison? AF: Well what we anticipated was that Turkey would be drawn into the Middle East conflict, that the regional powers would start to compete for influence as a result of all the chaos going on in Syria and Iraq. We foresaw Turkey and Iran becoming the most active competitors. Turkey primarily in Syria and Iran primarily in Iraq either directly or through proxies. And that has essentially just not been the case. Iran really has not come into competition with Turkey and the main reason for that is because Turkey has not engaged in Syria to the degree that we initially anticipated. The Turks’ primary concern right now in Syria is the Kurdish presence and that is because they see it as a threat to their domestic security and national integrity. Right now, they don’t need to worry about the security of their borders and the Kurds crossing over or anything like that. They’re still plenty occupied in Syria. On top of that we still have a government recovering from a coup that took place about a year ago. They had referendums and changes to their political organization. There were major changes to help consolidate power so the government is still working on that. Their economy is not performing as strongly as it was a few years ago and so they still need to address several economic concerns and we’re really seeing these items take up a lot of the time and resources of the Turkish government, and it is much more inward-looking than we anticipated. And it also is at a point where it can afford to be inward-looking. They don’t need to worry about any threats along their border at this point and time and that is also keeping them out of confrontation with Iran, who is under much more pressure to actively address the ISIS presence and chaos and fighting that’s going in Iraq and Syria because those activities are starting to directly affect Iran. And I know that we’ve seen some developments just in the past couple of days that, Xander, maybe you want to speak to a little bit in terms of where we see this going and where things are at the present moment of who’s talking to who and where there might be some room for engagement in the future. XS: Sure, an item that actually went out on our Watch List today had to do with Turkey, Iran and Russia stationing troops at different demarcation lines for de-escalation zones in Syria that have already been agreed to. And there is disagreement between Turkey and Iran, where their troops are going to be stationed. Turkey’s fear is Iran may station troops along a demarcation line that is too close to Turkey’s border and it seems like the disagreement in those negotiations may be an early indicator that some of what we were anticipating in our forecast is beginning to develop. But what did we end up giving ourselves on that forecast, Allison? AF: Well with that particular forecast we ended up giving ourselves a D, because we severely underestimated the amount of confrontation because of Turkey being so inward-looking. Which means that we’re much more off track than we anticipated, however, as I mentioned, it will be interesting to compare the final results at the end of the year with the ones that we have this year. XS: Yeah so even despite those early indicators, we just said we didn’t call it as of now in the year but obviously all of the issues that we discuss in our mid-year report card we will continue to track throughout the year. So those are some of the forecasts that we could’ve done better on that we missed outright. Allison, what about some that we were more accurate with? AF: So right now we’ve been accurate with several things. Some of the major ones would include the U.S. seeking to enforce and renegotiate trade deals like NAFTA and not pursue other multilateral trade agreements. The U.S. pulled out of the TPP in January. NAFTA negotiations are expected to start in mid-August this year. There’s been no more pursuit of the TTIP. These are all things that indicate that forecast was an accurate forecast and completely on track. Our forecast with Brexit in terms of the U.K. maintaining economic ties and business ties to the EU is still on track. Obviously, that depends on how things will change throughout the rest of the year with the negotiations and final terms of the Brexit. But that is something that is on track and actually is of importance in that initially they were one of the few people that were actually saying, hey this isn’t a big deal, this is business is going to continue as normal, these ties and relationships are too strong. So that’s notable in that sense. Our predictions with NATO and the U.S. pursuing closer ties with Eastern Europe are on track. Our forecast with oil prices not rising, especially as it relates to the Russian economy and not being enough to satisfy the budget and financial needs for the government to deal with social unrest, that’s on track. We’re still seeing protests throughout the country, wage arrears are continuing, the government is having financial issues. And then also some more upbeat economic forecasts that we have, which include East African countries having the high growth rates and really identifying some of the more emerging markets where there is a high growth potential, especially at a moment and time when the global economy isn’t growing as fast as it was say prior to 2008. And that would be economies like Ethiopia, Kenya, Tanzania, Uganda. We have so far been accurate on Brazil returning to growth this year, albeit very mild. It’s something that we see as notable in that it is South America’s largest economy and it just went through two years of recession where it contracted by more than 7 percent so even if we only see 1 percent, half a percent of growth this year, it’s notable, and that forecast is very much on track. So there are a lot of hits and if you take the time to read the entire report card, you will see that there are multiple items that are very much on track, some of them that are completely accurate that we would consider As, as well as lots of Bs. Those are easy to talk about, those are nice little pats on the back. And it was really important for us today to take the time to kind of address some of the more outstanding misses or misinterpretations of how we foresaw the world events evolving this year, to address those at this time. XS: So remember to check out our mid-year report card, it will be published tomorrow which is Friday, July 7 and the format will be sort of a graphic with shorter descriptions of each forecast and showing the grade right next to it and then if you scroll down further on the page, you’ll see a more detailed explanation of each of those forecasts and that will be available tomorrow.