The experience at J. P. Morgan led Payne and Murrin to launch Emergent’s first emerging markets fund in 1997. Emerging markets were universally viewed at the time as a highly specialized and risky area of investment. The common perception was that power was vested in the dominant American and associated European markets; very few appreciated that emerging markets funds were investing in the future engine of global growth. Today Emergent manages real asset, agriculture and hedge funds.
The Asian crisis (1997) and the Russian sovereign default (1998) confirmed the belief that these new markets were highly unstable. These two significant events, together with the later 2001 collapse of Argentina – once the darling of the emerging market world – showed that systems could fail despite appearing (even with IMF support and packages, in the case of both Russia and Argentina) to be both strong and well supported. Then came the cataclysm of 9/11 – not a random act of terrorism, in Emergent’s opinion, but a watershed in world affairs.
Geopolitics to dominate
Prior to this, it was economics that largely drove the understanding of investment, but Emergent believed that geopolitics would dominate the next decade. It was critical to find a model to explain and predict the new paradigm. The key issue was whether the US was facing decline. Having seen the unthinkable unfold in Asia, Russia and Argentina, from an emerging markets perspective, this was an obvious question, particularly in the light of the enormous and increasing US debt burden. Those from a developed markets background who had never experienced a national collapse could not entertain the prospect of the decline of the world’s superpower.
We identified six key themes: the multi-polar world; commodities; polarization; global military balance; disease; climate change. Applying these themes, Emergent has predicted shifts in geopolitical power, the dynamics of markets and the commencement of a new 25-year commodity cycle (from 2003). With this knowledge, for example, it focused in 2001 and onwards on small oil-exploration companies. The work with Heritage Oil (which, at the time, had a market cap of some $100 million) helped the company to raise critical funding for its investment in Uganda and grow into a multi-billion dollar concern. The firm went on to work with Seadragon, a company set to build two sixth-generation oil rigs, although, as a result of the 2008 credit crunch, Emergent was unable to secure sufficient equity funding and the project foundered. It was a sobering lesson that highlighted the weakness of the Western financial system to invest in the infrastructure that is so vital to ensure the security of commodities for its economies.
The commodity cycle starts with energy, is followed by metals and is completed finally by agriculture. Emergent went on record in 2006 identifying food security as the next energy security issue, and soon after launched its African Agricultural Land Fund. This, together with its operating company, is run out of South Africa under the name EmVest, which is dedicated to the development and management of the fund’s lands and industrial assets. The location of the project in Africa was determined by our model that charts the growth and decline of civilisations, and the resulting understanding of the potential of the Africa Sub-Saharan landmass. This has since been followed by an Africa Mining Fund within Emergent’s Real Assets division.
Meanwhile, Emergent’s hedge funds have been committed to the task of alpha generation and have outperformed in periods of high volatility. They performed strongly during the crises in Asia, Russia and Argentina, and again during the 2008 credit crunch, recording a top industry ranking by Bloomberg in 1997, 2001 and again in 2008. The 2008 credit crisis was predicted by the Five Stages of Empire model applied to the US and was understood for what it was: namely, the last empire of the West in overextension and decline. Emergent believes that its understanding of the shift of power from West to East will enable it to offer outstanding opportunities in its hedge funds in the volatile times ahead.
The financial world has suffered considerable criticism since 2008, much of it valid. The Western financial system, through the support of its governments, encouraged banks to leverage in the hope that by so doing they could turn what little incremental real growth existed into larger bottom-line numbers. As applied to the US, this is typical of an empire entering the final stages of overextension and decline. The geopolitical model described in Breaking the Code of History could, by its very nature, have only been derived fromthe environment of the financial world in which collective behavioural patterns can be identified and extended to the larger picture of history and world affairs. Consequently, it is our hope that these ideas might remind the reader of the positive contribution that finance and free capital markets have for over two hundred years made to what is described herein as the Western Christian Super-Empire. The ideas within these pages continue to inform Emergent’s view of the world and investment opportunities from the top down. They have allowed us to navigate the uncertain waters of the last decade and will guide us equally well in the coming years to the benefit of our investors. We hope that the book will provide positive insights and perspectives on world affairs, investment and good government, and will contribute to a wider public knowledge of the key issues facing us all globally over the next decade.
Five Stages of Empire
The Five Stages of Empire – a model of the growth and decline of civilisations – can provide a way both to understand history’s ‘big picture’ and to accurately assess current and future geopolitical environments. Empires are not all the same, of course, but the majority of them exhibit a similar distribution, peaking at about 60–70% along their life cycles. The Five Stages of Empire, then, are as follows:
2. ascension to empire;
5. decline and legacy
These five stages can be compared to the human life cycle, beginning with birth and a period of nurturing, and followed by independence, self-expression and the manifestation of one’s capabilities in the world. A peak is reached after, say, four or five decades; if it could be measured, it would comprise a mixture of wealth, energy, health, contentment, power and creativity. Finally, the decline towards death begins, completing the cycle.
As an empire grows, the world around it tends towards uni-polarity, until at its peak it comes to dominate its surroundings. Then, as it declines, there is a trend towards multi-polarity as it weakens and its neighbours strengthen.
Empires embody a critical dynamic balance between investment, defence, consumption and protectionism. The first two characteristics dominate the growth phases of an empire, as the rising power seeks to build its future and ensure its growth and survival. The third and fourth characteristics become dominant during the contractive phases, when the priority is protecting the status quo and maintaining a high standard of living, not investing in the future. (A comparison can be made with an elderly person who generally does not invest in their future but instead consumes during the last years of life.)
Demographics lie at the heart of an empire’s growth, and they provide a measure of its energy, predisposition to risk and value system. Moreover, all empires display a social composition divided between the core population and the workforce that has freed it to focus on expansion. As we have seen, in ancient times, slaves and serfs filled this role. Since the abolition of slavery in the West, they have been replaced by indentured labour, colonial subjects and the working classes.
Expansive and contractive phases
The first three stages of an empire – regionalisation, ascension and maturity – are associated with the qualities of expansion; optimism; appetite for both individual as well as collective risk; investment in national infrastructure; a sense of cohesion and national duty; social cooperation; pride in national achievements and values; and, as the limitations of material-world comfort are experienced, the search for individual happiness and spiritual fulfilment.
During the expansive phase, growth is not linear but occurs in spurts interspersed with pauses for consolidation. As the region or empire becomes more economically powerful, it seeks toextend its influence as far and wide as possible. There are no cases in history in which a wealthy country with strong demographics has not chosen to militarise its economic wealth, justifying such action by trade protectionism, territorial control, political influence and domination of the widest possible economic sphere.
With industrialisation, the size and power of empires have increased, along with the destructive potential of their war-making capacity. Nations must now carefully consider the cost/benefit analysis of making war. As a result, they may commit hostile acts that are economic rather than military by nature. The new global economy has helped by creating a common arena in which the players can compete in trade. However, it would be a grave mistake to be lulled into a similar false sense of security as were the nations of the world prior to World War One, who erroneously believed that the close linking of global trade mechanisms would prevent war. All global trade does is to raise the threshold for all-out war; it does not render it obsolete.
The last two stages of empire – overextension and decline – are governed by the process of decline. Its hallmarks include a lack of social cooperation (with a decline in resources every person begins to act in their own interest); an emphasis on the rights of the citizen as opposed to a sense of duty to the nation; protectionism; the inability of the empire to use foresight to invest in vital infrastructure for its future survival; unhappiness and a sense of exclusion; the fracturing of society into social sub-groups; social discord; and pessimism.
In considering political and economic forces at work today, six key underlying themes are discernible. These themes are inevitably interlinked.
The six themes
1. The multi-polar world. A marked geopolitical shift is occurring, away from the dominance of the US (as the last empire of the Western Christian Super-Empire) to the new powers rising in the East. In this new multi-polar world, attention must be paid not only to aspiring hegemons and civilisations in regionalisation or ascension, but also to the role of smaller countries and satellites (such as Israel) in the balance of world power.
2. Commodities: The Fuel of Modern Empires. As discussed, access to resources has always been essential for the growth of nations and empires. This is more than ever the case, with the Second Industrial Revolution now taking place in Asia. The demand for raw materials by both the developed and the developing worlds has precipitated competition for resources to a degree never before witnessed as the world draws from a resource pool that is historically at its most depleted.
3. Polarisation: The Road to War. This is the process whereby a collective binds together and defines itself. It creates positive cultural values but also acts as a focus for negative emotions, such as fear and anger. These are then projected onto another collective that is perceived to embody opposite values. The increase in both national and religious polarisation is a clear precursor to and justification for conflict. Polarisation can be thought of as the measure of a global friction coefficient: as polarisation rises, so does the likelihood of conflict.
4. Global military balance. The history of empires in any one period has been strongly tied to the balance of military power. The world today is no different. The greatest threat of destruction remains the proliferation of nuclear weapons, but we are also now witnessing a conventional arms race that is slowly building in Asia. Moreover, the threat of biological and chemical weapons, along with the possibility of continuing advances in the US missile defence shield strategy, could once again alter the balance of power.
5. Disease and Empire. In the past, disease and epidemics have not been random events but rather the productof collective social trauma at different stages of empire. The speed with which we now move around our planet enables infection to spread with potentially catastrophic consequences, which modern medicine may be unable to contain.
6. Climate change. The changing biosphere is linked to the acceleration of human population growth and industrialisation, with profound geopolitical implications. The question is not whether climate change is a reality but the rate at which it will radically affect the world around us, and the cost to both the natural world and human civilisation.
The commodity cycle
The fundamental premise of the Five Stages of Empire model is that throughout history, human beings have conducted their affairs according to specific patterns, repeating them without conscious awareness. The patterns operate over the long term, but, consistent with fractal dynamics, shorter-term patterns can also be observed.
The brilliant Soviet economist Nikolai Kondratiev followed a similar logic, positing that human behaviour and response constitutes a critical factor in determining cycles of prosperity. (He exerted considerable influence over the Soviet economy until 1927. Arrested in 1930, he was executed eight years later during Stalin’s Great Purge.) In the mid-1920s, Kondratiev studied capitalist market economies and developed his Wave Theory, which proposed that alternating cycles of rising or falling commodity prices (plotted as sinusoidal K waves) follow a set, predictable pattern in economics. K waves, according to the theory, averaged approximately 53 years each.
In practical terms, a K wave represents around 25 years of mounting commodity prices (see Fig.3), peaking before entering a deflationary or downward cycle for another 25 years. It follows that a consumer society dependent on raw materials at low input prices would suffer during the first part of the cycle, as the cost of commodities appreciated. An economy supported by the extraction and export of raw materials, on the other hand, would benefit. As discussed, access to commodities is critical in determining geopolitical power; in the ascending part of the K wave cycle, therefore, competition for resources pushes up commodity prices, increasing geopolitical friction. This dynamic results in significant conflict at the end of a cycle – for example, the Napoleonic Wars, the US Civil War, World War One and the Vietnam War.
Empires that are in the process of building their power on commodity production are positively affected by peaks in the Kondratiev cycle, while industrialised empires that heavily consume commodities are affected positively by troughs. The corrective cycle therefore significantly influences where a given empire can be situated within the Five Stages of Empire model.
The Cold War makes for a good case study of a K wave in terms of the geopolitical ramifications of the theory. The US, which by 1945 had outgrown its indigenous supply of resources and was dependent on large-scale importing, squared off against the commodity-rich Soviet Union, which derived its wealth from commodity prices. Soviet power relative to the US peaked at the time of the Vietnam War – the Cold War’s main proxy conflict. The USSR then slid into a 25 year decline, attaining its lowest point in 2000. This slump accelerated from 1980 onwards, following the Soviet invasion of Afghanistan. The US formed a partnership with anti-Communist Saudi Arabia to suppress oil prices, with the intention of bankrupting the USSR, a strategy that could only be achieved during an underlying bearish trend. Since 2000, by contrast, there has been a reversal in the relative power aspirations of Russia and the US. This can be expected to continue over the next two decades.
As a commodity cycle builds towards its peak, limited supply and increased demand cause prices to rise. Consumer nations compete at such a level of intensity that conflictis engendered. Prices then soar even more vertiginously, creating a clear commodity spike. Alarmingly, the most recent cycle began only in 2000, yet by mid-2008 it was already exhibiting qualities (namely, the level of competition) that would normally be present at the end of a K wave. Swollen and rising levels of population and industrial demand have taken us to the limits of resource availability. Oil is, of course, the most glaringly representative commodity in this context, and food is likely to be next. This commodity cycle is unlike any other economic phenomenon ever observed; there are simply not enough resources to accommodate the global population. The situation is one of the utmost seriousness.
A brave new multi-polar world
At the turn of the 21st century, the notion that within a decade the seemingly indomitable power of the US and Western Capitalist democracy will be in decline would have been unthinkable throughout most of the world. However, the power shift from the West to the East is now only too apparent, and the indications are clear for those who choose to see them that the rate of this massive geopolitical shift will now only accelerate and its consequences exceed anything most people can perceive. Yet being able to entertain a vision of this future is not enough; we also need an insight into its mechanisms.
In this section I shall consider not only what can happen but also how it might happen. Using an understanding of the principles of the empire cycle, we might choose to navigate the rough waters of our unconscious collective behaviour in order to arrive at a new geopolitical paradigm.
Imagine, if you will, two tectonic plates of enormous scale that have, over centuries, built up tremendous forces at their interstices. They appear immobilised and inert until, without warning, all of that pent-up energy is released in less than a minute. The result, of course, would be an immensely destructive earthquake. Such tectonic stresses are analogous to geopolitical tensions, and since 2000 we have been witness to the greatest build-up of such tensions in history – not merely between empires but, for the first time, between the world’s first two super-empires: the declining Western Christian Super-Empire (WCSE) and the burgeoning Asian Super-Empire (ASE).
Given the six geopolitical drivers that were discussed – multi-polarity, commodities, polarisation, global military balance, disease and climate change – as the West-to-East transition unfolds, I believe that it is inevitable that, unless addressed, the geopolitical tensions caused by Chinese expansion and the competition for resources will bring the world to a third global war. This will happen not at some indefinable date in the future but by 2025, as the current commodity cycle reaches its peak. Indeed, in many ways, the second decade of the 21st century bears an uncanny resemblance to the ten years preceding World War Two. The question is, faced with such a potentially disastrous future, what steps can be taken to change the patterns of human behaviour to prevent the occurrence of another world war?
Sun Tzu and The Art of War
The world we live in is being changed beyond recognition by the increasingly rapid growth of China. In this process of transformation, the Chinese have an important advantage over the West. While they have a complete grasp of Western cultural values on account of the last two centuries of global dominance by the WCSE, the converse is not true: the West is trailing woefully behind in knowledge of its rival. The West, blinded by its ideal of the primacy of democracy and the Capitalist model, fails to recognise that China’s culture, arguably the oldest and most sophisticated in the world, has its own primacy in terms of its appreciation and application of strategy. Of particular and chilling import for the West, given China’s recent rise as a challenger on a global scale, is its historical and philosophical understanding of the art of war.
Resource scarcity and conflict
As the Five Stages of Empire model clearly demonstrates, wars are fought for the singular purpose of resource acquisition, cloaked by various ideological or religious rationales. The constriction of access to resources has, therefore, historically been the most significant catalyst for conflict. Population growth in the developing and industrialising world is now exerting intolerable pressure on the world’s resources, and major conflict is all but inevitable as we approach the next Kondratiev peak in 2025. Attempting to ignore this build-up to war is unjustifiable and inadvisable.
As the US and Europe continue to stagnate economically while China grows rapidly, pressure will be maintained on commodity prices feeding through to the continuation of high input prices and the dynamics of inflation in China. However, with no growth, the West will suffer the ignominy of stagflation – the worst of all worlds economically. In this environment, China will hold its own with moderate real growth, while the West contracts with negative growth and endures the social consequences that come with such decline.
Meanwhile, commodity-producing countries (in particular those with the rare resource of oil) will continue to prosper as long as they are well managed economically, with balanced budgets based on realistic oil prices. Strategically, this is the time for countries to learn from the price spikes of the second decade of the 21st century, and to invest in resource acquisition to prevent the consequences of the new spike. However, the West is in decline and relatively impoverished; only China and perhaps the Arab Gulf states will think in this way. With the East in strong positive growth and the West in negative real growth, the decade from 2010 to 2020 will see the former overtake the latter at triple the traditional speed.
Returning to the concept of fractals, I should like to consider the position of the entire human race according to the Five Stages of Empire model. Geopolitics takes place at the level of individual states competing for resources, with the result that some, driven by demographics, become empires. Super-empires emerge as a collective made up of empires, or regional powers led by an empire, as with the WCSE and the ASE, respectively. The greater fractal would take in the planet as a whole, positing the Earth as an empire in its own right. Where is the world as a whole on the empire cycle?
There are several key indicators providing insight into this question:
1. The planetary biosphere is past the point of being able to sustain an endlessly proliferating human population that is undergoing a second wave of industrialisation. We are living at odds with our environment and consuming at a greater rate than allows for replenishment.
2. The global social structure is two-tiered. The WCSE, with its neutral demographics, is steadily relinquishing power to the emerging states, consistent with the transfer of power that begins just prior to an empire’s decline, when traditional elites give way to those formerly subjugated.
3. Increased social stress, which is the result of competition for increasingly scarce energy, water and food resources, prepares the path for war and disease to devastate the population.
These signs all suggest that the human race is balancing at the frontier between overextension and decline in a regional planetary cycle, with our population curve verging on plague levels. To prevent potentially devastating consequences for the planet’s billions of inhabitants, it is imperative that we become aware of currently unconscious behaviour patterns, and realistically confront and resolve the huge problem of population. Voluntarily lessening demographic pressures by reducing populations is an option, although as a remedial measure it is not politically acceptable virtually anywhere in the world. It may only be viable once a majority has beenpersuaded by overwhelming evidence, and by then it would simply be too late.
However, confronting this issue must become part of a coordinated foreign policy among the developed countries, and would best be integrated with the issues of disease and climate change. Recruiting China and India to this perspective would be a major advance, although realistically, assuming that these countries well understand the relationship between demographics and power, they would have no motive for subscribing to any measures that would limit their progress towards empire.
These excerpts are drawn from ‘Breaking the Code of History’ by David Murrin. He has 23 years’ experience in the directional trading of markets after earning an honours degree in geophysics from Exeter University and working initially in seismic exploration in Papua New Guinea. Murrin worked at J. P. Morgan in London for before co-founding Emergent Asset Management in 1997.
Breaking the Code of History
Helping investors understand historical cycles
DAVID MURRIN, FOUNDER AND CHIEF INVESTMENT OFFICER, EMERGENT ASSET MANAGEMENT
Originally published in the February 2011 issue