To say we live in difficult times is not to belabor the obvious or be trite.  The four horsemen of our apocalypse are well known.  

The pandemic is still with us in a profound way, and many developing countries do not have access to sufficient vaccines to inoculate a significant part of their population.  They may not until next year.  Meanwhile, the US and Europe debate the protocols of a third jab. Unfortunately, Mother Nature is not waiting for humans to get their act together.  New variants, like Mu, which was first detected in Colombia and shows "a constellation of mutations" that may overcome the immunity response of the vaccines, are emerging. Mu has been officially recognized and is being tracked by the World Health Organization.  

Next to the public health crisis rides the bizarro world of finance.  There is a widely shared sense that something is profoundly wrong and ultimately unsustainable.  There are around $14.5 trillion of negatively yielding bonds from Europe and Japan. The ECB has lent funds to member banks at minus 1% if they re-lend the money.  The flood of capital has seen credit spreads narrow.  The price-discovery process is dysfunctional. Savers get paid little (and below zero in real terms) to lend to most major countries and are not rewarded commensurately for taking on more risk.  Central government deficits have become the "normal" feature in high-income countries since the Great Depression.  Central banks' balance sheets emerged as a policy tool in the Great Financial Crisis.  It never fully left, and it appears now the struggle is to normalize it.  Valuations in other asset markets, including equities and house prices, especially in the Anglo-American countries and parts of Europe, are stretched.  New assets, like Bitcoin, appear to be based on nothing but a limited supply generated by a computer algorithm and non-fungible tokens, are the rave.  

The next horseman bears some relation to the world of finance, but it was independently sired.  The disparity of wealth and income is powerful.  It acts as a corrosive force, weakening bonds of social trust and undermining the legitimacy of the political and economic elite.  The social contract lies in ruins.  Parents in the US and other high-income countries can no longer be confident that their children will live better than they do.  College education can cost more than a house in the US and not lead to the upward class mobility of earlier generations.  If negative interest rates mean that capital cannot reproduce itself,  then the disparity of wealth and income is such that the middle class is struggling to reproduce itself.   The pandemic underscores the fact that poverty itself is a comorbidity.  Indeed, wealthy people have better access to health care, nutrition, and education.  It is hardly surprising that longevity itself is a class issue. 

The fourth horseman is the largest and most potent threat.  It goes by the sanitized name "climate change," which does not do justice to the radical changes we are only on the cusp of now.  We have known about it for a generation.  Initially, the focus was on conservation and the limited resources for an increasing population, like Limits to Growth (1972), an updated-Malthusian critique.  But the thrust morphed, and in 1980, the Green Party was founded in Germany, which may participate in the next national coalition government.  A noted American ecologist, Barry Commoner, helped launch the Citizens' Party and ran for president of the United States in 1980.   The warming temperatures, rising sea levels, and greater weather volatility are not unexpected.  It is the pace of change that is surprising.  The UN's latest report (Intergovernmental Panel on Climate Change) warns that mitigation efforts need to be more ambitious.  The extinction rate of animal and plant life puts our era in the sixth place in earth's history.   This horseman can reshape continents and dramatically alter coastlines.  Roughly 40% of the human species presently lives within 100 kilometers of an ocean.  Let that sink in.  

However, as powerful and notable as the four horsemen are, it is the fifth that brings us here today.  What is most notable about it is its stealth.  The other horsemen are well known, discussed, and debated. Yet, it seems that only a specialized audience even recognizes the fifth one.  It does not have a name, but if it did,  it might be called Eris, after the Greek goddess of strife, or Gungnir, after Odin's spear. This horseman announces the waning of nuclear deterrence and the risk of a new arms race.  It is about diverting resources that may be needed to defend against the other horsemen and endangering life as we know it.  

From a high level, the achievement of nuclear stability can be understood as the preservation of second-strike capability.  The first strike is the initial attack. The second strike is retaliatory.  The capability of it deters the first strike, hence mutually assured destruction.  One consideration that follows from this is that defensive weapons that could deny an adversary second-strike capability would be destabilizing.  At first, this was not a problem because it was beyond the scientific capabilities of the Americans or Soviets.  And when defenses began being more practical, the 1972 Anti-Ballistic Missile treaty was signed between the US and the Soviet Union, limiting the number and scope of the deployment of defense systems.  

Things change.  The rising nuclear threat seemed to come from rogue states (e.g., North Korea and Iran) and possibly non-state entities.  For this kind of threat, a missile shield could be desirable but risks undermining the stability of the second strike.  Technology continued to evolve, and Israel's Iron Dome has demonstrated its efficacy for various kinds of projectiles (e.g., mortar shells, unmanned aerial vehicles, rockets).  Some reports give it an 85-90% success rate since the first deployment in 2011. Moreover, the technology has been exported.  It has, for example, been deployed and helped defend Saudi oil pipelines.  

Technology evolves.  At first, the precision of the missiles was lacking.  But if the idea is to signal to the adversary that one will have sufficient resources after absorbing the hit from their strike that can destroy large population centers (Mutual Assured Destruction), then the missile's accuracy may not be so important.   If a missile is off even a few miles from its target, it may not make much of a difference.  Military strategists call this counter-value targeting.   However, technology has developed remarkably, and the precision capability allows for a different strategy:  counter-force.  Consider being able to target enemy missiles in their silos.  

Now, put these things together: The US withdrew from the ABM treaty in 2002 and continued to develop missile defenses. A  few months ago, it tested one of the two Iron Dome defense batteries in the United States purchased from Israel.  The idea is to integrate it into the US defense array but also possibly be portable.  Under President Trump, the US successfully tested the "Ground-based Midcourse Defense" system, the only US missile defense system built specifically to address Inter-Continental Ballistic Missile (ICBM)-class of threats.  When the defensive capabilities are joined by the precision and number of US missiles and warheads, its first strike capability can be daunting.

Leaving aside the particulars about Russia and China's current leaders, simply assume rational actors, at least as the base case.  What kind of response is likely?  What would we advise if the US found itself in a similar position?  

The country in the subordinate position would use asymmetrical warfare, like George Washington and the Continental Army did against the British.  It is an often-used tactic by the militarily inferior position. It was deployed by the Israelis against the British and is used by the Palestineans against the Israelis.  It is time-tested and is even recounted in Bible stories.  If an adversary can dominate the top of the escalation ladder, one may be tempted to dominate lower rungs of the ladder and seek marginal advantages that will not be raised to the nuclear level, like North Vietnam did and North Korea continues to do.   

The enhanced first-strike capability of an adversary would also argue in favor of building more missiles to bolster the chances that a sufficient number survive to make a credible second-strike threat.   It cannot really be unexpected that China is building an estimated 250 nuclear missile silos across three locations.  Silos are not missiles, and there may be multiple silos per ICBM like the US maintains.   One tactic would be to have some decoy silos.  Another would be to move the missiles around, like a shell game, so the precise location may not be known, thereby preserving second-strike capability.  Yet, another response that does not preclude the others is to hide the second-strike capability, such as on quiet submarines or perhaps, in orbit.   

While the number of missiles is an important metric, remember that a single missile can carry multiple warheads, and each warhead can be aimed at a different target.  The Federation of American Scientists estimates that China has about 350 warheads, while the US and Russia have 4000 warheads. China may be seeking military power commensurate with its considerable economic heft.  It may be watching the rise of India's nuclear capability.  As often seems the case, Beijing's policies could be aimed at achieving more than one objective.  Assuming rational actors, the US absolute and relative capability can only provide additional incentive to modernize and expand China's nuclear and conventional capability.  

There are many ways the Xi has deviated from the course that China had appeared to be on since the late 1970s and Deng Xiaoping's political and economic reforms.    It previously had a minimum deterrence strategy, shy of the Mutual Assured Destruction level but still quite powerful. In this way, it was like France's Force de Frappe.  It might not have been able to kill the bear, but it could tear off one of its legs, leaving it vulnerable to internal convulsions or external pressure.  Presently, France is estimated to have about 300 warheads, which is sufficient to raise the cost of a first strike to apparently unacceptable levels. Xi may have decided that the given the technological developments of precision-guided weapons and defense capability, even a minimum deterrence needs to be larger. 

America, NATO, and some of China's neighbors are worried about the modernization and expansion of China's military capability.  The concern is only heightened by Beijing's continued aggressiveness in the region and not just in Taiwan's airspace.  It is perceived to be the neighborhood bully. China's build-up will be used to justify more military spending in the US and in others in the Asia Pacific region.  

Our species' ability to hurt its own and foul its own nest seems to be nearly boundless and unique in the animal kingdom.  Every era has its own threats and challenges.  Perhaps to be aware of them is also uniquely human.  Today's horsemen shake the very root of our civilization.  Public health and class mobility had been taken for granted in a way that they cannot be anymore.  We live in a Gilded Age., which is showing its age.  The vast amount of negative-yielding bonds is like an alarm warning that something is wrong.  It has become part of the white noise we tune out.  Amidst the elevated state of distrust and nationalist impulses, the fifth horseman of the apocalypse strides and pulls the carpet from underneath where nuclear deterrence stood for a generation.    

Opinions expressed are solely of the author’s, based on current market conditions, and are subject to change without notice. These opinions are not intended to predict or guarantee the future performance of any currencies or markets. This material is for informational purposes only and should not be construed as research or as investment, legal or tax advice, nor should it be considered information sufficient upon which to base an investment decision. Further, this communication should not be deemed as a recommendation to invest or not to invest in any country or to undertake any specific position or transaction in any currency. There are risks associated with foreign currency investing, including but not limited to the use of leverage, which may accelerate the velocity of potential losses. Foreign currencies are subject to rapid price fluctuations due to adverse political, social and economic developments. These risks are greater for currencies in emerging markets than for those in more developed countries. Foreign currency transactions may not be suitable for all investors, depending on their financial sophistication and investment objectives. You should seek the services of an appropriate professional in connection with such matters. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete in its accuracy and cannot be guaranteed.

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