Smoke Signals

The AI stock market stampede and Pope Leo's warning, why Jersey is fighting for its financial future, is Europe prepared for peace in Ukraine, and why El Niño could deliver the next economic shock

Here’s this week’s newsletter. If you find it at all valuable, please do consider becoming a paid subscriber as it’s the generous support of paying subscribers that keeps this going. At the very least, you can show your appreciation by hitting the “like” button which helps with the algorithms and sharing it widely with anyone you think might be interested. I look forward as always to your comments and feedback.

Next week, I will be in Brussels where I will be participating in a panel discussion at the Wilfried Martens Centre on Wednesday on the somewhat surprising topic of what lessons Europe can learn from post-Brexit Britain. Details here. Answers on a postcard. I will be in Brussels most of the week and again the following week. Please do get in touch if you would like to meet. In the meantime, here is today’s menu:

• AI Stampede: Papal Bull

• Lessons from Jersey: Slow Puncture

• Is Putin Losing? Smoke Signals

• El Nino Cometh: Be Prepared

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1. Papal Bull

It’s a dangerous business trying to call the top of the AI bubble. Most commentators pinned the blame for Friday's dramatic sell-off — the biggest one-day drop in US stock markets since "Liberation Day" in April last year — on a strong jobs report that increased bets on a rate rise later this year. The tech-heavy Nasdaq fell 4.2 per cent, while the SOX semiconductor index, which had surged more than 80 per cent this year, suffered its biggest one-day decline since the onset of the pandemic in March 2020, plunging 10.3 per cent.

But there is rarely one explanation for a market sell-off. After all, nothing quite screams top of the market more than the sight of the biggest tech companies in the world queuing up to tap public markets for tens of billions of cash. Alphabet, owner of Google, announced plans to issue $80 billion in new shares. SpaceX confirmed its eye-watering $1.75 trillion IPO, followed by news that Anthropic has confidentially filed plans for its own $1 trillion-plus listing. Meta is reported to be eyeing its own jumbo share issue following Google’s. The stampede has a distinct late Nineties feel of insiders cashing in before the music stops.

And the music may be about to stop — not because of interest rates, but because of the growing public backlash against AI that threatens the entire premise on which these valuations rest: that AI development will continue unconstrained. The clearest exploration of what is at stake for society can be found in Pope Leo XIV's recent encyclical, Magnifica Humanitas, a remarkable document that deserves to be read in full.

In it, the Pope called for AI to be "disarmed" through regulations and guardrails to shield societies from mass joblessness, exploitation, deepening inequality, manipulation and misinformation. He warned of autonomous weapons, bioweapons and mass surveillance. And he zeroed in on the extreme concentration of power that AI promises to place in a very small number of private hands. That concern is fully justified. As Wealth of Nations previously noted, SpaceX's IPO will allow Elon Musk to retain 82 per cent of the voting rights in a $1.75 trillion company in which millions of retail investors will find themselves invested via tracker funds (see Oligarchification).

Some of the loudest warnings have come from within the industry. Just last week, Anthropic published a blogpost calling for AI labs to pause frontier AI development to allow regulation to catch up, citing the approaching moment of “recursive self-improvement” — the point at which A.I. models are able to improve themselves without human intervention. As of last month, Anthropic noted, 80 percent of the code added to the company’s code base was written by its Claude model. Its co-founder Jack Clark, told BBC News “the industry has a gas pedal, but it doesn’t have a brake pedal”.

Washington appears to be belatedly — and reluctantly — starting to pay attention. Donald Trump last week issued an Executive Order establishing a framework for AI labs to submit frontier models to the government 30 days before public release. The trigger was alarm at Anthropic’s powerful new Mythos cybersecurity models that raised the spectre of hackers using AI to undermine the US financial system. Compliance is voluntary and earlier plans for a 90-day inspection delay were shelved so the impact is likely to be minimal, but the direction of travel seems clear. As Sebastian Mallaby at the Council for Foreign Relations noted, “it makes little sense that novel drugs must be rigorously tested before going to market while no equivalent procedure is imposed on AI labs.”

Meanwhile, a proposal backed by OpenAI’s Sam Altman for a public fund to take shares in AI companies so that all citizens can benefit from their success last week attracted two new supporters from polar ends of the US political spectrum: Bernie Sanders and Donald Trump. The US president floated the idea of the US government taking stakes in AI companies, while the left-wing senator proposed the US government taking 50 percent of their shares. I’m sceptical that “Universal Basic Capital” will assuage anxieties over joblessness. More likely, it will cement a cozy relationship between Silicon Valley and Washington to the detriment of the public and US competitiveness. Nonetheless, Trump’s interest is acknowledgement that distrust of AI is emerging as a risk to US tech supremacy.

Of course, any real attempt to contain the kind of social harms identified by Pope Leo will require international cooperation, above all between the US and China. And though Trump and Xi Jinping did briefly discuss AI safety at their recent summit, there seems little chance of any agreement on that front, not least when both sides consider the AI race to be existential to their geopolitical competition. For the same reason, the US will continue to resist doing anything that might hold back US companies in the race against China.

That leaves the protection of what the Pope calls the magnificence of humanity dependent on the self-restraint of AI companies themselves. And yet, as Dealbook notes, any decision to slow or pause AI development, or to establish an AI non-proliferation treaty, could put at risk the “astronomical” valuations that they are relying upon to raise the hundreds of billions of dollars needed to fund their investment plans. The companies are asking investors to fund a future that their own safety warnings suggest may need to be curtailed. No wonder they are seeking to fill their boots before the market cottons on.

For a fascinating insight into the multi-disciplinary, multi-faith Pontifical Academy of Sciences, whose origins go back 400 years to Galileo, this short podcast is worth your time

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2. Slow Puncture

The imminent 10th anniversary of Brexit is prompting a deluge of analyses of how Britain has fared since the referendum. For Bloomberg, Paul Davies considers the impact on the City of London, concluding that it has fared much better than many feared, adding more than 67,000 jobs and retaining its pre-eminence in foreign exchange, derivatives trading and international debt issuance. The one area where London's star has "truly fallen" is in the stock market — a phenomenon frequently noted in Wealth of Nations (see How Brexit Wrecked the Stock Market).

My suspicion is that this is much too complacent. I never believed the City would suffer a sudden post-Brexit shock but did think it was vulnerable to a slow puncture — and there is evidence that this is what is happening (see The Overwhelming Case for Rejoin). It's true that no single European rival has emerged to challenge London. But plenty of business and jobs have migrated, dispersed across multiple centres. Anyone who has recently been to Paris, Milan, Madrid, Amsterdam or Dublin cannot fail to be aware that these cities are thriving as a result of resurgent financial services sectors. Should the EU get its act together with the creation of its savings and investment union - a project which took a step forward last week with an agreement by the six largest member states on common financial supervision - London could lose out again.

To see the slow puncture at work, though, look not at London but at the country's secondary financial centres, where the cushion of incumbency is thinner. A case in point is Jersey — not strictly part of the UK but a Crown Dependency off the coast of France — for whom Brexit is a major factor in a looming existential crisis for an industry that supplies 40 per cent of its gross value added and 40 per cent of its tax revenues. The island has already fallen to 38th place in the latest Z/Yen index of global financial centers, down from 13th in 2009. Ahead of this weekend’s elections to the States Assembly, the island’s parliament, I visited last month to assess the challenges it faces and wrote about it for Bloomberg.

Jersey's core problem is that its biggest business — administering funds for private equity and other asset managers — has fallen victim to EU rules requiring all funds marketed to European investors be administered in EU jurisdictions, which no longer includes Jersey. At the same time, its banking sector, which once did brisk business providing tax-free services to expats, has been undermined by UK post-financial crisis ring-fencing rules, which mean that surplus deposits can no longer be lucratively parked with UK banks. The number of banks on the island has shrunk by a third since 2017.

Jersey also finds itself increasingly having to compete with new financial centres in the Middle East and Asia that barely existed two decades ago. In this year's Z/Yen survey, Singapore and Dubai far outstrip rivals as the centres considered most likely to become more significant in the coming years. London has been vulnerable to this same eastward shift, and Jersey, which depends on London for most of its deal flow, is feeling the squeeze. Worse, new risks loom in the form of AI, with automation bearing down on the administrative and back-office functions that employ much of the island's 14,000-strong financial workforce.

To give Jersey its due, it is not taking this threat lying down. The outgoing government commissioned a clutch of reviews, which resulted in the March publication of “Time to Win,” a report laying out a strategy for the next government to reinvigorate Jersey’s financial-services sector. Its core message was that “the privilege has shifted,” arguing that for decades Jersey operated on the assumption that access to the island was itself a privilege; now, though, Jersey must go out and compete for business like everyone else.

Nonetheless, the island’s harder problem may be cultural. To attract a new generation of internationally mobile financial professionals, it will almost certainly have to reform strict local housing laws that dictate where new arrivals can live and impose a 10-year residency requirement before they can buy a home. It will also need to develop the kind of amenities — schools, hotels, entertainment — that such professionals expect. The faded 1950s provincial English aesthetic, a legacy of its past as a destination for mainland holidaymakers before the era of cheap flights, is not an obvious draw.

Whether Jersey can make the transition remains to be seen. But at least it is aware of the problem and is seeking to get ahead of it. In contrast, the City's apparent success in navigating Brexit risks breeding complacency, oblivious to the slow puncture. Formulating a response is complicated by the fact that the commanding heights of the City are now almost entirely in the hands of foreign institutions. As Huw van Steenis, vice chairman of Oliver Wyman, tells Paul Davies, it is striking that there are hardly any global desk heads among the big US investment banks based in London these days, in contrast to a decade ago. That hollowing out of domestic leadership is itself a symptom of the puncture. Jersey, at least, has recognised that the privilege has shifted. London not so much.

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3. Smoke Signals

Back in the years before Russia’s invasion of Crimea and eastern Ukraine, I attended the Russian Davos, properly known as the St Petersburg International Economic Forum (SPIEF), several times. Each occasion was highly memorable, not least the time when I attended a reception for speakers at the Hermitage, only to find that I had this vast treasure trove entirely to myself for the evening. Although not there myself, this year’s SPIEF produced its own unforgettable image, that of delegates arriving against a backdrop of a giant plume of black smoke rising from the St Petersburg oil terminal hit by Ukrainian drones.

It was the most visible symbol of the fact that, over the past weeks, something quite significant has changed in the course of the Russia-Ukraine war. The initiative has swung towards Ukraine in ways that seemed very unlikely at the start of the year, or indeed the start of the Iran War, which many feared would hand the advantage to Russia. Consider the following developments:

• Bloomberg reported that officials in Russia's Finance Ministry and central bank have advised the Kremlin that projected defence expenditure risks the budget deficit widening dangerously — and that the surge in oil prices from the Iran war won't be enough to resolve the problem. The deficit for the first four months of the year expanded to 5.9 trillion rubles, or 2.5 per cent of GDP, about 50 per cent above the full-year plan, and the economy contracted in the first quarter for the first time in three years.

• Volodymyr Zelensky taunted Putin with a scorching 1,800-word open letter, warning the Russian president that his regime would not survive the war, and proposed a face-to-face meeting to end the conflict. Putin, speaking at SPIEF, predictably rejected talks, dismissing the letter for its “rudeness”. But Zelensky's power play reflects both Ukraine's improving military position — Russia is starting to lose occupied territory while Kyiv's drones and missiles reach ever more sensitive infrastructure — and the fact that Ukraine is no longer beholden to the United States.

• Signs are emerging of a split within the Russian elite. A widely-discussed piece in Russia’s foremost foreign-policy journal by Vasily Kashin, director of the Center for Comprehensive European and International Studies at Moscow’s Higher School of Economics, argued that Ukraine will inevitably remain an anti-Russian, pro-Western country, especially after hundreds of thousands of Ukrainians have been killed or maimed in the war. The goal of installing a friendly regime in Kyiv—one of Putin’s original objectives—is no longer realistic, Kashin argues; Moscow should settle for a frozen conflict.

• Despite Trump’s continued efforts to help Russia — he even sent a delegate to SPIEF to announce a symbolic Russia-US hockey match and sign a memorandum of understanding on a tunnel under the Bering Strait — pro-Ukrainians in Washington are starting to stand up to the president. Last week, the House defied Trump to vote for Ukraine aid and increased Russia sanctions. It won’t come to anything, because Trump remains opposed, and has even eased sanctions on Russian oil, but the political space for supporting Kyiv is widening as Trump’s power wanes.

• It was also striking that Secretary of State Marco Rubio implicitly acknowledged last week that the Steve Witkoff plan whereby Kyiv would give up those parts of the Donbass not yet occupied by Russia, is no longer a realistic basis for a deal since Ukraine’s battlefield success means that Russia can no longer count on conquering them by force. That amounts to a rejection of what Putin calls the “Anchorage Understandings”, the agreement he thought he’d reached with Trump at a summit in Alaska last year behind Zelensky and European leaders’ backs.

Of course, it’s important to keep one’s excitement in check. The fact that Russia finds itself on the back foot on the battlefield may be as likely to lead to escalation rather than an exit ramp. It’s striking that many of those around Putin are reportedly arguing for widening the war beyond Ukraine and even using nuclear weapons to force a surrender. As Jack Watling, a military expert at RUSI, argues in Foreign Affairs, Ukraine’s manpower shortages make a military defeat of Russia implausible. A more realistic goal would be an unconditional ceasefire.

The challenge for Europeans, then, is twofold: to help create the conditions that would tempt Putin into a ceasefire, and then to shore up Ukraine during what would almost certainly be a period of intense vulnerability as it tries to turn that ceasefire into a durable peace. Does Europe have a plan? As Ben Judah noted in a thoughtful post last week, that will require some hard decisions not just for the EU and Nato, which Kyiv wants to join, but also for the UK. Almost every major European war in modern times has led to the establishment of a new continental system. What will emerge this time and what will Britain’s place be in it?

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4. El Niño Cometh

As if the world doesn’t have enough to worry about, here comes El Niño. Last week the World Meteorological Organisation issued a blunt two-word instruction to governments worldwide: “Prepare for El Niño.” The latest forecasts put the probability of El Niño conditions during June to August at 80 per cent, rising to above 90 per cent through the autumn. Most models suggest it will be at least moderate and possibly strong. Some climate scientists are going further, warning of a potential “super” El Niño — a level of Pacific Ocean heating not seen since 1877, according to European climatologists tracking a massive subsurface Kelvin wave of warm water racing east towards South America.

For investors, the implications are clear enough. El Niño typically puts upward pressure on cocoa, rice, sugar and food oils, while threatening crop yields across South Asia, southern Africa and parts of East Asia. The World Bank warns that rice output in affected regions could fall by 20 to 50 per cent. Coming on top of the Iran war’s disruption to fertiliser supply chains — urea prices spiked 46 per cent in a single month after the Strait of Hormuz was disrupted — the combination could produce the most severe food inflation shock since 2022.

What’s more, higher temperatures boost electricity consumption for air conditioning, straining power grids while reduced rainfall cuts hydroelectric output, notes Bloomberg. Drought can lower water levels in the Panama Canal, slowing cargo traffic through one of the world’s busiest shipping bottlenecks. Scientists at Dartmouth College looked at the lingering five-year fallout from El Niños and estimated that the 1997–1998 event led to $5.7 trillion in lost gross domestic product globally.

What with wars in the Middle East and Ukraine, a technological revolution and AI-driven stock market mania, and now a looming climate event, the list of things to worry about in the second half of 2026 is starting to look uncomfortably long.