We begin this week’s newsletter by examining the possible consequences of a conflict between Israel and Iran, highlighting the recent attacks on Hezbollah from Israel. Next, we turn our focus to the potential fiscal crisis looming over the global economy. We then shift to a discussion of whether China’s stimulus measures will be enough to prop up its ailing economy. Finally, we conclude with an analysis of the state of the war in Ukraine, possible outcomes, and Russia’s recent change to its nuclear doctrine.

Middle East on the Brink

Iran bombards Israel as the war escalates further

The Economist

Hassan Nasrallah’s death will reshape Lebanon and the Middle East 

The Economist

Middle East’s power scales tip as Israel senses Iran’s weakness

John Sawers, The Financial Times

The recent assassination of Hezbollah leader Hassan Nasrallah by Israeli forces on September 27th has significantly escalated tensions in the Middle East, potentially pushing the region closer to a full-blown regional war. This event, part of a series of calculated strikes against Iranian-backed militias, has triggered a wave of violence and retaliation. Israel, perceiving an opportunity to reshape the regional power dynamics due to Iran’s perceived weakness and emboldened by its military superiority, targeted Hezbollah with the aim of dismantling the group’s leadership and infrastructure. This calculated campaign, influenced by Israel’s increasingly right-leaning domestic politics, seeks to exploit what some perceive as a unique moment to solidify Israel’s position in the region.

Hezbollah, in retaliation to Nasrallah’s assassination, launched rocket attacks into northern Israel, prompting the evacuation of Israeli citizens and providing justification for Israel’s ground invasion of Lebanon on October 1st. In a significant escalation, Iran launched a direct ballistic missile attack on Israel on the same day, marking a dangerous turning point in the conflict. While the attacks were largely neutralized by Israeli and American defense systems, they underscore the heightened risk of a wider regional conflict. Israel, seeing Iranian vulnerabilities and potentially encouraged by the United States, may view this situation as a chance to neutralize the Iranian nuclear threat, a long-standing goal of Israeli hawks. However, this aggressive approach carries significant risks, as cautioned by analysts who highlight the dangers associated with Israel’s incursion into Lebanon. The situation remains highly volatile, with the potential for miscalculation and further escalation looming large and likely.

Global Fiscal Crisis

BlackRock’s Fink Says Market Is Wrong on Fed Rate-Cut Bets 

Anchalee Worrachate and Loukia Gyftopoulou, Bloomberg

Solving the Global Fiscal Policy Trilemma

Victor Gaspar, Foreign Policy

The Debt That Shall Not Be Named

Michael R. Strain, Project Syndicate

The global fiscal landscape is in disarray as public debts and deficits rise to distressing levels. The US has not been immune in recent years as it faces escalating debt, the rise of inflationary policies from the government, all the while attempting a soft landing for its economy. Speaking on the US economy, BlackRock CEO Larry Fink recently highlighted the disconnect between market expectations for Federal Reserve rate cuts and the reality of persistent inflationary pressures driven by government policies. Speaking at the Berlin Global Dialogue 2024, Fink expressed cautious optimism about US economic growth, believing the economy will grow by 2%-to-3% this year, particularly fueled by public-private infrastructure investments, while highlighting geopolitical risks, including China’s alignment with Russia. He also pointed out the mounting global fiscal challenges, with spiraling national debts and geopolitical tensions reshaping the uncertain future of the world economy. Yet, political inaction on addressing fiscal imbalances threatens to undermine long-term economic stability, as both US presidential candidates, Kamala Harris and Donald Trump, remain notably silent on the nation’s perilous fiscal trajectory. As debt continues to rise, with projections of a US debt-to-GDP ratio reaching 122.4% by 2034, investor confidence is likely to falter, pushing interest rates higher and triggering inflationary pressures.

Further complicating the global economic outlook is the “global fiscal policy trilemma”, where governments must balance increasing spending on defense and climate change, public resistance to higher taxes, and the pressing need to reduce deficits. Achieving this balance is nearly impossible without difficult trade-offs, such as cutting spending or raising taxes, both of which carry political risks. This scenario mirrors the fiscal tensions of the early 1980s, when unsustainable debt levels triggered a global debt crisis. Today, spiraling national debts, fueled by unchecked government spending on programs like Social Security, Medicare, and interest payments, risk diverting critical funds from defense, research, and infrastructure investments, further eroding economic prosperity. The global economy now depends on policymakers’ ability to navigate this complex trilemma, while also addressing geopolitical pressures and inflation risks that continue to destabilize global markets.

Will China’s Stimulus Be Enough?

China Weighs $142 Billion Capital Injection Into Top Banks 

Bloomberg News, Bloomberg

China’s stimulus is hefty but insufficient 

The Editorial Board, The Financial Times

Is China’s new stimulus a strategic pivot in policy or a short-term tactical move? 

Ji Siqi, Frank Chen, and Amanda Lee, South China Morning Post

Fear of a Soviet-style collapse keeps Xi Jinping up at night 

The Economist

China is set to inject $142 billion into its six largest state banks, marking the first major capital infusion since the 2008 global financial crisis. This move is part of a broader economic stimulus package aimed at reviving the struggling economy, with funds sourced from special sovereign bonds. The capital is intended to boost the banks’ lending capacity, supporting key sectors facing economic challenges, such as real estate, local government financing, and the stock market. Despite the banks maintaining capital levels above regulatory requirements, they are grappling with record-low margins, rising bad debts, and diminishing profits, necessitating government intervention to stabilize the sector. This capital injection, while substantial, is not unprecedented. China has a history of intervening to support its state-owned banks, notably during the late 1990s and the early 2000s to address surging non-performing loan ratios. However, this latest move underscores the challenges faced by the Chinese economy and the government’s commitment to utilizing various levers, including its powerful banking sector, to stimulate growth and restore confidence.

This economic action unfolds as Xi Jinping grapples with deeper fears of a Soviet-style collapse, a concern that haunts his leadership. As China celebrates its 75th anniversary, surpassing the Soviet Union’s 74-year reign, Xi’s speeches reflect worries about internal decay, weakened by years of prosperity. He frequently warns officials of the dangers of “nihilism” and factionalism, fearing these could undermine party unity. His purges and ideological campaigns aim to rebuild party discipline and enforce loyalty, but his reluctance to groom a successor raises concerns about instability after his rule, evoking the memory of the Soviet Union’s turbulent fall.

Bleak Outlook for Ukraine War

The war is going badly. Ukraine and its allies must change course 

The Economist

Where Is the War in Ukraine Heading? 

Carl Bildt, Project Syndicate

Putin Declares Changes to Russian Nuclear Doctrine 

Anton Troianovski and Ivan Nechepurenko, New York Times

The conflict in Ukraine, now well into its third year, shows no signs of abating, with a costly and unsustainable war of attrition defining the current landscape. Ukrainian President Volodymyr Zelensky’s recent visit to Washington in September 2024 was framed as a bid for renewed arms and financial aid, but the situation calls for a far more strategic shift. Russian forces have been advancing, particularly around the eastern city of Pokrovsk, though at great cost, with estimates suggesting up to 1,200 Russian soldiers killed or wounded each day. However, Ukraine, with a population five times smaller than Russia, is also experiencing significant losses. Military lines could collapse before Russia exhausts its war effort, a critical concern as Ukraine braces for another winter of blackouts, with Russia’s destruction of the power grid set to cause up to 16-hour outages across the country. Public fatigue is growing, mobilizing and training new troops has become increasingly difficult, and there is a palpable gap between the desire for total victory and the current means to achieve it.

Meanwhile, the international landscape is shifting as well. In Europe, political pressure to reassess Ukraine’s support is mounting, with far-right parties in Germany and France criticizing the allocation of resources to the war effort. On the other side of the Atlantic, US politics is in flux as Donald Trump—who could potentially win the presidency in 2024—signals a willingness to cut a deal with Russian President Vladimir Putin that could undermine Ukraine’s territorial integrity. These dynamics underscore the necessity for a redefined approach. Instead of pursuing the unfeasible aim of reclaiming all territories lost since 2014, including Crimea, Western leaders must work with Zelensky to refocus Ukraine’s war aims on securing long-term prosperity and Western alignment. NATO membership must be made a credible offer now, as this is key to both securing Ukraine’s future and deterring Russia from continuing its military aggression. Such a move, though controversial, could re-calibrate the conflict toward a sustainable outcome, ensuring Ukraine’s security and positioning it for eventual peace without surrendering to Moscow’s territorial ambitions.