Later this month, President Trump will be sworn in. By the close of March, Article 50 is expected to have been triggered in the UK, marking the official start of Brexit. Together, these formal rituals will reify the shock political decisions of the last year. Much has already been written on the various political or macro-social implications of these shocks. It is my intention, however, to look more closely at whether these shocks are truly indicative of increasing political instability and, if so, how this instability should be factored into global planning by wealth creators and holders.
Political instability in the ‘West’
It’s important to understand the sort of instability we are discussing with greater objectivity than can be found in the emotionally charged and politically biased headlines of the day. Firstly, I want to confine my analysis to the traditionally politically stable areas of North America and Western Europe – places to which wealth has for many decades flowed to escape less stable regions of the globe. Secondly, we need to start from the understanding that the two examples already cited – Brexit and Trump – are in fact both examples of the normal functioning of the democratic process in their respective nations. There has been no great change in the democratic process with either of these examples, despite the hyperbole in the press, and the market reactions have so far been notably muted in comparison to the great shocks that we were warned would accompany such decisions. It is important, therefore, not to exaggerate the nature of these changes.
Despite this, however, both examples were shocks to the political ‘establishment’ and are indicative of a sea-change in mass ideology towards anti-establishment memes and particularly popular nationalism. This isn’t confined to these markets either, with Austria, Belgium, Bulgaria, Denmark, Finland, France, Greece, Hungary, Italy, Romania, and Slovakia all showing various forms of polarization of political opinion and the growth of nationalist movements. Another nuance to note at this juncture is that although nationalist movements have been the big winners of 2016, not all this substantial growth in anti-establishment sentiment has been on the traditionally nationalist right. Many countries are also seeing swells of support for either new socialist movements or the socialist fringes of traditional left-of-centre parties, such as has happened with Labour and the Momentum movement in the UK and almost happened with Bernie Sanders in the US. With a few exceptions, these socialist movements are generally much further from gaining political power than their opponents on the right, however, with Marine Le Pen in France gaining significant national traction ahead of upcoming Presidential elections being a good example.
Commentary on the make-up of these anti-establishment movements tends towards over-simplification. Nationalist movements do have a strong base in young, poorly educated, low-income, ethnic-majority males who are driven by economic insecurity, but this is far from the whole story. As far back as 2011, a Chatham House Study correctly identified the fact that right wing parties have been gaining ground across a wider voter base including many economically secure older households because, “Contrary to the conventional wisdom that these citizens are motivated by feelings of economic competition from immigrants and minority groups, feelings of cultural threat are the most important driver of their support. For these citizens, the decisive motive is the feeling that immigration and rising diversity threaten their national culture, the unity of their national community and way of life.” With the data we have now, we can add surprising levels of support from middle class women to that right-wing coalition.
Whether this anti-establishment radicalism can be labelled extremism is a politically charged decision that is best avoided. It is undeniable, however, that it is successfully mobilizing large voting blocs in favour of parties with a stated interested in making large changes to the politically moderate status-quo. This means potential further volatility in terms of economic and foreign policy, with left wing movements a potential threat to wealth holders and the nationalist movements a potential threat to the goals of international trading companies. Whilst the monetary institutions of the Western world are at least theoretically independent of political changes, fiscal and trade policies can change very quickly and have a profound impact on wealth creators and holders.
The billion-dollar question is whether we can expect further political instability because of these growing movements, or whether the shocks of 2016 have opened the valve and released the worst of the built-up pressure. Worryingly, there are empirical studies that suggest the developed West is experiencing ‘democratic deconsolidation’ – a broad undermining of support for the liberal-democratic institutions that have traditionally brought stability. Yascha Mounk, a lecturer in government at Harvard, has tracked ideological support for democratic versus autocratic institutions in the developed West and found the trend is towards a weakening in support for democracy as a method of governance, a trend which has been witnessed in many apparently stable countries prior to a significant period of destabilization, such as Venezuela. For my part, I believe a lot will rest on the perceived performance of the Trump administration and the Brexit deal – if they go well, we may end up with a new, relatively pro-business status quo; if they go poorly, the de-consolidation we have seen may mean that future shocks will have a more profound effect on the liberal-democratic structure of these societies.
The impact on wealth planning
Political stability is widely seen as the third most important element in selecting a jurisdiction in which to do business, just behind ease of doing business and reputation (STEP Offshore Perceptions Report 2016). This might give some reason to re-assess the traditional flow of wealth from developing markets into the West, but I would not over-state the potential for this. Crucially, whilst we may see growing political instability in the West, the liberal-democratic structure of those societies does ensure that volatility will look different than it does in other global regions, at least in the short to medium term. Rapid and unexpected political changes in a country such as Italy or America could lead, for example, to rapidly changing trade environments, tax levels, or regulatory shifts that could substantially impact on wealth creation. Politically motivated asset freezing or confiscation, or even threats to personal safety, are much less likely to occur than they are during rapid regime change in countries with less of a liberal-democratic culture.
That said, it would be overly simplistic to argue that ‘Western volatility’ is only a threat to future wealth creation – wealth holders will have noted with concern recent developments in the UK and EU that give a baseline capacity for wealth confiscation. Firstly, there was the discussion of deposit seizure as an acceptable methodology for handling a financial crisis in the EU, following the Cypriot case. Secondly, there is the UK tax authorities’ move towards the Direct Recovery of Debt (DRD), under which HMRC may respond to perceived tax violations by extracting funds directly from a bank account, prior to any legal proceedings. Third, UK tax legislation is more frequently being applied retrospectively upon coming into law and after only relatively short consultation periods. Whilst these may not be major risks for compliant wealth holders now, they could become so in a changed political climate, and in this context democratic de-consolidation is worrying.
Looking at the UK and US more specifically, wealth holders nevertheless have reason to be relatively optimistic. All the indicators show that whilst the Republican and Conservative parties are incorporating more nationalist and perhaps even protectionist policies into their agendas, they do remain heavily ‘pro-business’. Mainland Europe may give investors more reason to be cautious at this time, however, with countries such as Greece, Italy, and Spain being both closer to financial crisis and more exposed to the migrant crisis that is impacting on feelings of cultural insecurity.
So what will be the key trends in the near future? I believe we can expect more instability, but the locus will be outside of the UK and USA, where the populations wait to see the results of the change they have mandated in recent voting. Foreign exchange markets will remain volatile, creating as many opportunities as challenges for investors, and we can expect protectionist policies to become the norm, leading to changes in global supply chains and probably inflationary pressure.
Perhaps counter-intuitively, I believe the proper response to the threat of political change is to select jurisdictions which change very rapidly. In this, I am referring to the smaller international financial centres that have built their offering around legislative agility and specialized service economies – the Isle of Man, Malta, the Channel Islands, and perhaps to a lesser extent jurisdictions such as Gibraltar or Luxembourg. They are less prone to ideological politics and large swings in policy, yet they use rapid incremental changes in legislation enabled by their small size to ensure they remain consistently legitimate and pro-business.
Whilst all of these jurisdictions are compliant with international standards on tax and transparency, and Malta is even within the EU, they all nevertheless work hard to maintain competitive advantage for wealth holders and creators and have a more vested interest in continuing to do so. Their independence also gives them a degree of insulation from foreign shocks. Ultimately, this is why we have built a diversified service offering delivered from several offshore and onshore offices. Of the various jurisdictions on offer, each has different advantages for different forms of wealth management, but in the context of a reliable and consistent jurisdiction for general structuring, we remain strong proponents of the Isle of Man. It is legislatively independent and most of those legislators have no party affiliations, it has had over 30 years of unbroken economic growth despite incurring almost no public-sector debt, and it has a diversified enough industry base (compared to close rivals) to make its domestic economy more resilient than many other small nations. Families and corporate directors seeking safety would be well advised to consider it for wealth structuring.
It is, as always, an interesting time to be in wealth management!