Middle East conflict, AI and the next economic shift

Why the next market shift may come from politics, not economics.
 
In this episode of "What’s Brewing? With Matt & Guy", Head Political & Government Affairs Matt Holmes and Chief Market Strategist & Economist Guy Miller unpack the forces shaping today’s economic landscape from geopolitics to AI.

- Is AI going to end humanity now?
- What's the impact of Middle East conflict on energy markets and global trade?
- What does it all means for growth, inflation and investment outlook?

Transcript

0:00

[Subtitles are AI generated][Engaging Music starts] Matt Holmes, Head Political & Government Affairs, Zurich Insurance Group: the concerns, the perceptions of the broader public.

Guy Miller: 0:07

This was going to be a very, very difficult situation to find a resolution to.

Matt Holmes: 0:11

It was always inevitable that you were going to have a political check at some point.

Guy Miller: 0:15

Europe seems to love challenges because they seem to be constantly fighting something.[Music ends][Subtitles are AI generated][Music starts] What’s Brewing with Matt and Guy. Matt, it's been a while. How have you been?

Matt Holmes: 0:27

I've been good, Guy. I've been missing you, obviously.

Guy Miller: 0:29

Listen, last night something very strange happened. Somebody came up to me and said, they watched our episode. I think he's one of our perhaps super fans.[Music ends] Matt Holmes: Listen, to all of you out there, please do like and subscribe. But listen, what he asked me about was what's going on in the Middle East. He asked me what's happening in markets. But do you know what he really wanted to know about?

Matt Holmes: 0:47

No, what?

Guy Miller: 0:48

What the outcome of the World Cup is going to be. Now, listen, I'm Scottish. I don't know what shape or size of ball they use. You're English. I'm not sure you do either, but any words of thought, of genius about who could win this? Guy obviously England favorites and I think we will get a new Prime Minister in the UK just in time to welcome the World Cup home finally. One part of that is true. We will probably have a new Prime Minister. I'm not sure about the winning the World Cup. Anyway, let's keep hoping. Let's keep hope. Keep hope eternal. Now, given our superfan wanted to know what is happening in the Middle East, since we last spoke, has much changed? Are you more optimistic? Have we got a result?

Matt Holmes: 1:25

Well, when we last spoke, we were hoping for a quick resolution to what was a very nasty conflict, having fairly dramatic impacts on world energy markets.

Guy Miller: 1:34

So I guess three months later we have a resolution

Matt Holmes: 1:35

Yeah, things haven't changed that much. I mean, look, we look like we have the basis for a resolution to the conflict, but I think instability is inherent in what's going on politically there. I think the US are very keen to... Get Hormuz Strait open again. They need to bring the Iranians to the table. The Iranians know they've got political leverage in those negotiations. I'm not sure the Israeli government is entirely comfortable with where things have landed. But look, they're all talking. They're all moving in roughly the right direction. And we are starting to see ships moving again. But I don't think we're ever going back to that status quo ante where there was a free and easy flow of shipping through the Strait of Hormuz or not. Not in the short term anyway. So we're going to have to live with the consequences of this war for some time yet. And I think it's an interesting indication of the sort of new geopolitical world that we're living in and some of the inherent instability that comes when you have the sort fraying of multilateralism. Maybe we're moving into a sort of post North Atlantic treaty organization universe, more unilateral action, greater incentives for secondary powers, regional powers to flex their muscles and try and get some advantage. And I think what we have seen with the Iran war is quite how difficult it is for the US to entirely extricate themselves from those sorts of conflicts.

Guy Miller: 3:04

I might go further because I can certainly see it's in both sides' interest to find some form of resolution here. But when I look at what the resolution could be, keeping to the football analogy, isn't this really been one very big own goal for the United States?

Matt Holmes: 3:20

Well, I mean, maybe it's a score draw or 0-0, but I mean it's difficult to look at the outcome and say this is a clean victory. But you know, as I say, I think at this point in time, the clear focus is to make sure that shipping flows again, that we get back to a stable operating model for the Gulf. And that seems to be what's on the table. We'll to see how it plays out and I'm sure that there will be. Wobbles in the ceasefire over the coming weeks and months.

Guy Miller: 3:50

I mean, a few months ago when we last spoke, I mean my feeling was, you know, the genie had been let out of the bottle. This was going to be a very, very difficult situation to find a resolution to. Three months on, it sounds like we're moving in that right direction. But from what you're saying, there is an undertone there, which is even if we get the shipping flowing again, which from my side in economics and markets is very important, but the stability in this region, it certainly hasn't been improved. But would you go further say that it has been been undermined.

Matt Holmes: 4:21

Look, I think you've seen come to the surface fractures that have been there for a long while, but the ability of individual actors to exploit weaknesses or take opportunities has changed over the last five years, right? I mean, I think that that is something that's global, probably not just in the Middle East. And we will see more conflicts, more shooting wars crop up around the globe as a result. I think one silver lining here, I guess, is that the impact on the global economy seems not to have been as significant as we might have feared and that we are stopping the missiles flying in time to avoid real crunch time in global markets because of the constraints on oil supply. But maybe I'm too optimistic there.

Guy Miller: 5:05

I think one of the big true surprises has been is how robust and resilient trade has been and actually global growth has been because there were a lot of people opinioning or opining on the notion that actually if the Straits were still closed by the end of June, which it pretty much was, then the price of oil could be 150 plus dollars. That was not the case. I think what we've seen again is societies find a way of circumventing getting Ryan roadblock. We saw very much that. I think the big surprise was China. I mean, China was in a position where we know now that they had been stockpiling strategic reserves significantly at very low prices. And it wasn't just, of course, the reserves within China, but they had made sure their supply chains were well stocked. So, actually, production really wasn't impacted. Not only was production not impacted, but all imports fell quite dramatically, partly because of the reserves they had, but I think importantly because One, they were converting coal into coal gas, so there was some way that they were able to do that. Secondly, they had moved rapidly in terms of the electrification really since the start of the year. So again, that surprised me about how quickly and how significant that was. But what we have seen is actually on a inflation-adjusted terms, the price of oil, even at its peak, it only got to around its 20-year average. I think that was a surprise to many. And it allowed trade to continue. And it allowed economic growth to...

Matt Holmes: 6:35

So we've got greater resilience in global trade than perhaps we might have feared at the start of the year. That's positive, but I'm also conscious that this is a repeat game, right? I mean, resilience gets eroded each time you have to be tested. At some point, governments run out of reserves and fiscal headroom that might be there to cushion increasing energy prices will be run down. And we're looking at potential additional moves on tariffs in the coming weeks. There are a few anti-dumping reports due from the US side that could see tariffs introduced in various new areas. You've seen the Chinese moving to identify and be ready to exploit points of leverage on critical inputs to manufacturing around the globe. We've seen in the last couple of months, the Europeans start to actually put pen-to-paper on some... Uh, industrial policy protectionist measures, but look, I mean, the point is that, I mean, maybe the sort of, we're not going to see a repeat of the fireworks of 2025 in terms of big bang tariffs, but this game isn't over, and it's still being played through.

Guy Miller: 7:46

So maybe a few points on that because I think these are very valid points. So on the first point, I would say that yes, absolutely, the resilience has been there, but we're constantly having to show that, to prove it, because really what we've seen since the pandemic is we know about dependencies, we know what vulnerabilities. So supply chains have been broadened, broadened. We've had to have more reserves in place across supply chains. There is a cost to all of that. This is inflationary, ultimately, isn't it? Well, it can be. And I think the first thing is that the supply chains are arguably not as efficient in terms of the cost of production. I would argue they're more efficient because they're resilient in many ways. And I was a part that was never priced.

Matt Holmes: 8:28

So it's a sort of hidden cost that's now...

Guy Miller: 8:30

But the other thing is that I think is very valid is given what we've been saying over the period, China has continued to export more. The surplus that they have continues to rise.

Matt Holmes: 8:41

But that's where these moves by the Europeans to start to push for, buy European, look at how they can promote European industrial manufacturing, I mean, all of these are moves to try and counter that threat of being hollowed out by Chinese capacity.

Guy Miller: 8:57

Congratulations. You tell me, aren't we like five or ten years too late for that?

Matt Holmes: 9:00

Yeah, but they're still going to put in place those barriers that risks triggering a response from China. And we see that escalation risk.

Guy Miller: 9:09

Yeah, but even within the EU construct, we've seen clearly different countries have different objectives. Some clearly don't want that. Some maybe do. And isn't that always the problem with Europe is having that single voice, it's bringing people together to have a common policy to fight that.

Matt Holmes: 9:27

It's its strength as well as its weakness. I mean, we're talking about resilience, and you want that sort of optionality. And part of that comes through the European process. I mean, you are forcing EU member states to compromise on some of their own domestic objectives in order to deliver for the benefit of the whole. That is a slow and painful political process. And you're absolutely right when it comes to industrial policy, when it comes to trade more broadly. It is not easy to align domestic political interests with what needs to happen at the EU27 level.

Guy Miller: 9:57

And the way the world is running now, slow policy, slow processes, it's not compatible with a dynamic working environment. And whether it's the industrial side in Europe that is being arguably hollowed out by now high quality imports, again, coming from China, whether it is a tech space where Europe doesn't have a great exposure there.

Matt Holmes: 10:22

Well, I think the tech space is where this is probably most acute as a problem. I mean, you've got very, very clear political awareness across European capitals and quite how far behind they are on the AI capability front. Sovereign AI, sovereign cloud is what the European Commission has just published a paper and is going to push legislation to try and achieve. But they're starting from a long way back. And the level of at the moment for Europe. US tech is, you know, 90 plus percent. I mean, this is extraordinarily dependent. What other option is there? They don't have the infrastructure at the moment to be able to run sovereign clouds. They've got ambitious plans to encourage data center build out. But at the movement, the time scales for those data center builds in Europe are two, three times how quickly they can be turned around in the US. So there's a real challenge there. This is something that politically, I think, the Europeans are gonna... Screw up their courage to be able to do this.

Guy Miller: 11:21

Well, listen, Europe seems to love challenges because they seem to be constantly fighting something. And I think what you kind of allude to there is really important. I should point out though, I mean, Europe has many great companies, but I do believe that the structure that they have is at a disadvantage to the US. But one thing I wanted to ask you about is. I think we've seen a fundamental shift in terms of how people think about AI and technology, and more importantly, data centers. Now, it's not that there haven't been fears about jobs. That's been around really since the beginning. But when I look at the US, I mean, this is, you know, this is a land of the free.

Matt Holmes: 12:01

The pitchforks are out for the AI.

Guy Miller: 12:03

And we've seen, I think, with the current administration, a shift. I mean clearly, they were very much in favor of AI and data centers, big technology companies, all of that was great. And it helped the market.

Matt Holmes: 12:13

Look, there's nothing like an election to focus minds, and midterms are looming large in the political consciousness of all US politicians, whether Republican or Democratic. And it's clear that you're not going to get many votes for standing full square behind a big data center which may not employ too many people and could or is perceived to be a risk to increasing energy costs or competing with local farmers for water. And we see that very clearly. There's, what, 100 billion plus of data center projects which are currently on hold or tied up with permitting pauses because of that political pushback.

Guy Miller: 12:52

So what you're saying basically is that the big advantage that the U.S. Had in all of this, they're shooting themselves in the foot by becoming anti-Almas, anti-detect movement.

Matt Holmes: 13:02

I think this is part of what you have to live with if you're a democracy. You're going to have to balance the interests of the majority of people over time if you are going to create support for a big technology change. I think maybe the Silicon Valley tech giants have had it easier than they might have over recent years, but it was always inevitable that you were going to have a political check at some point, whether that's regulation are in the interests of national defense or national sovereignty. The block on Antropix Fable and Mitos being distributed and that sort of intervention from the White House.

Guy Miller: 13:40

But here's my challenge as a market guy, right, simple market person, you know, I like the market and the market forces to be working, free flow. Now, what I'm seeing in the United States, you know, whether it's taking stakes in big tech companies or whether it should be reducing sales, never an example of this.

Matt Holmes: 13:59

There's never an example of a market functioning without some government intervention.

Guy Miller: 14:03

Of course. But we're seeing more of it. Always you

Matt Holmes: 14:05

need the parameters to be set. You need the rules of the road to come from the legal system, from the regulators. And the idea that there was just going to be some sort of free-for-all and go ahead guys, develop this potentially existential threat of a technology without any government oversight was a dream.

Guy Miller: 14:23

So you don't think the US today is any different from the US in past cycles? Because I do. I think there's a fundamental shift here. I think that there's shift away from free capital markets. Of course, we have to have rules, regulations and parameters set. But I see more and more state intervention, whether it's allowing companies to sell or to export, whether it is the government taking more stakes in the company.

Matt Holmes: 14:46

More state intervention than we saw in the New Deal in the 1930s or with the Roosevelt trust busting at the start of the 20th century. I mean, these are all critical and important interventions.

Guy Miller: 14:55

Was any of that really helpful?

Matt Holmes: 14:56

Well, I mean it didn't stymie US growth and the US becoming the most powerful and important economy in the globe.

Guy Miller: 15:02

But it's another obstacle. I mean, what I have some sympathy for, and I think the challenge is going back in history, we had periods, whether it was Standard Oil, whether it was even in the 80s and 90s when we were talking about, you know, do our companies just simply becoming too big? Do we need to break them up? I was never a great fan of that because you just end up having But now we're in a position where these companies are so big.

Matt Holmes: 15:23

None of those companies were sitting on technology which could potentially end humanity. I mean, this is not something that I'm speculating on, you know, listen to Dario and Modi.

Guy Miller: 15:34

So AI is going to end humanity now. You had a bad morning this morning, didn't you?

Matt Holmes: 15:39

I'm not saying that's what's going to happen. I'm just saying that the ability of AI, the more sophisticated AI models, in the wrong hands to cause very significant damage in the real world is there already. When we look at the risk of cyber and this fabled and mythos release from Anthropic being blocked, it was precisely because of fear. That in out in the wild, this could very quickly become something that creates a massive systemic problem. Now, that's different from standard oil. I mean, yeah, maybe if you wanted to create a cartel and you could shift the price of oil, but you're not talking about something that in the wrong hands could take down whole economies or could be used to really challenge the civilizational model that we don't know.

Guy Miller: 16:27

I remember what you remind me of, it was that Luddite movement, remember the

Spinning Jennies? Matt Holmes: 16:31

Well, you know.

Guy Miller: 16:32

But look, on a serious note, there's two things I would say. One is, we know there's always resistance to change, humans feel uncomfortable with change, the uncertainty that creates, and I fully agree, right now, it's a lot of uncertainty. I mean, I see that still as a positive. One of the things I agree with Jeff Bezos on is that throughout the entire history of technological development and human progress is that... I know it's an old one again, but more jobs have been created in aggregate than have been lost. And we don't know what type of jobs are going to be created as a result of this. I still think it's very early days, by the way, but I think that, you know, putting the resistance up, the heckles getting up, their brakes are going on, that stifles in my opinion.

Matt Holmes: 17:15

You have You have to deal with the environment in which you're operating. And if you are an US-based AI company, you are operating in a democracy, same in Europe, right? You have account for the fears, the concerns, the perceptions of the broader public. And the problem at the moment is that the negatives are starting to become much clearer than the long-term payoffs are. It's easy to persuade somebody that they might struggle or their children might struggle to get a job in a graduate market, which is having to compete with AI. It's harder to sell them on the potential upside that might come 10, 20 years down the line. And there are parallels here, I think, between the tech revolution that we're living through here and the energy revolution that was triggered around the concerns on climate change. around the concerns on climate change.

Guy Miller: 18:05

Agreed. I mean, one thing I will say is because we have just launched our mid-year outlook and I absolutely understand the challenges our face and all the points that you've made. In the shorter term, however, we're still pretty optimistic in terms of the outlook for the cap spending cycle.

Matt Holmes: 18:23

Music's still playing, is it going?

Guy Miller: 18:24

The music is still playing, the Kool-Aid is still being drunk, and I think just a couple of things on that. One is that all of this funding that we're seeing from these hyperscalers coming to the market in terms of debt issuance, one has to remember that yes, they're taking on some debt, but they have got very low levels of leverage. I mean, they've got very robust balance sheets. So yes, you're taking on that, but I still think this is more financial engineering or optimizing of that. Secondly is, of course, all this money they're raising, now that is the revenue for the rest of the tech space globally. We're seeing a lot of companies having super normal profits. We're see semiconductors of course explode in terms of pricing, DRAM pricing. We've seen Apple having to raise their prices and we've got to keep an eye on that because there is a little bit of an inflation element coming through in that space, even though it's a small share of CPI. But to us, this still has got further to run. And although we speak about this massive capital spending in terms of defense, renewables, AI. It's still, when we look at it on a global stage basis, a relatively small part of GDP, and you like history as you're leading to...

Matt Holmes: 19:30

The rest is being spent on pensions, is it?

Guy Miller: 19:31

Well, I'm going to say compared to previous cycles or previous big breakthroughs in technology, really where you started is that, you know, there's still a lot of headroom to go there. So a lot challenges, a lot potential, you know, political, even geopolitical risks still out there. But at the company level, at least for the next six months or so, again, I still think there's some positives that one should not over, should overlook here.

Matt Holmes: 19:54

So we should end on a positive there. England winning the World Cup, no correction in markets in the next six months, and political headwinds are there, but they're not going to stop growth. I like that.

Guy Miller: 20:04

I suspect your World Cup has just undermined your credibility

Matt Holmes: 20:09

as a commentator on anything.

Guy Miller: 20:11

But to all our listeners and viewers, remember we would like to have more than one subscriber. So please do like and subscribe as always. So much to talk about here. You can tell that we've got an interesting debate going internally here. Really interested to hear your views.[Music starts] So please put comments down, put challenges down. How do you see the world? That would be really helpful as well. And until next time. Let's hope things do work out. I'm not sure about the outcome of the football, but we look forward to speaking to you again very soon.[Music ends][TITLE: Zurich logo. Comment. Like. Share]