With nation states ‘applying 19th century statecraft in a world of 21st century weapons’ it comes as no surprise that geopolitical risk remains the biggest concern for businesses around the world. What are the potential flash points and what might they mean for businesses?
Geopolitics is the largest risk the financial markets face in 2018. At least, so says a survey commissioned by Barclays among 700 of its institutional clients. Other risks mentioned are Fed tightening, unanchored inflation expectations and a growth slowdown in the rich countries. There is something for everybody, in other words.
We tend towards the notion that some market parties may have played ‘the joker’ when answering the questionnaire. Perhaps it is laziness? There is a sense that “all is well, growth will not be coming under attack any time soon”. As investors are not aware of any big risks, they may have opted to just mention a sweeping term such as geopolitics. If this is correct, the geopolitical risks have hardly been priced in (if at all) as yet. The implication is that geopolitical crises could have a significant impact on prices.
The question is what are the risks that fall under the heading of geopolitics? Very relevantly, the global security situation is deteriorating. We foresee a new weapons race, which differs from the one during the Cold War in an important and worrying way. There was a race between two blocs at that time, whereas now it is a matter of everyone for themselves. Intentions and capacities are more opaque and there is a growing chance of accidents and escalations.
The organisation monitoring weapon sales has identified three reasons for the higher expenditure. Namely, the introduction of new and large-scale weapon systems, ongoing military conflicts in various countries and mounting regional tensions.
The worsening safety climate goes hand in hand with the crisis that democracy faces. The number of fully-fledged democracies has been decreasing for approximately a decade. The support for (and quality of) the principles of democracy is also steadily decreasing in existing democracies whereas the idea of a ‘strong leader’ is gaining popularity.
Democracy faces three major challenges:
Income and especially wealth inequality, polarising societies and the inexorable flow of news about corruption scandals have undermined confidence in democracy.
Social media provide authoritarian regimes with more opportunities to exert control and simultaneously allow them to fuel tensions and discord in the democratic countries.
China’s unprecedented success which undercuts the idea that democracy is the best or only way to achieve prosperity and peace.
A decline in security and democracy goes hand in hand with difficult relationships between nation states and the markets; especially the financial markets. States tended to be all-powerful in modern history until recently, but the financial markets have stolen a march on the sovereignty of governments – and then some – in the past decades.
It is no accident that James Carville, one of Bill Clinton’s important advisers, famously said in the early 1990s, “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a 400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”
It is increasingly clear that the financial markets do not offer any solutions to growing inequality, stagnating wages and job insecurity. On the contrary, they often facilitate these developments.
We see escalating international security risks, democracy in choppy weather and tensions between nation states and the financial markets. It would be so nice if the global world order that evolved (particularly) after the second world war, largely shaped by the West, would continue to provide some form of stability and security. Unfortunately, this is not the case, particularly as the world’s policeman – America – under President Trump is undermining the certainties and pillars that support the global order.
Trump likely opts for this approach in order to divert attention from the domestic problems and pacify his financial backers, while really believing that the US should steer a unilateral course with narrow defined self-interests as a compass. According to some, he relishes going against conventional wisdom. In the meantime, he is exacerbating the exact same problems and tensions that have brought him to power. The chance is slim that we will see any improvements in this area in 2018.
The US course side by side with China’s seemingly unstoppable advance, causes many major economies to worry about how to maintain ties with America and China. We foresee a gradually shifting focus from Washington to Beijing. The security and economic relations with the United States and China are being revised in many areas; Beijing is often the beneficiary of this change.
The relationships between the other large economies play out against the backdrop of what may be the 21st century’s major geopolitical narrative. Whereas before, only a very select group of economies was really important to the world economy, the developments in and between far more countries than before have become relevant to the global financial markets, due to the unprecedented economic growth and intertwining interests of the past decades.
We are seeing more mutual dependence and political/economic collaboration but also more competition. Plus, nation states are – in the words of Brookings Institute’s Bruce Jones – “applying 19th century statecraft in a world of 21st century weapons”.
Owing to these shifting geopolitical sands, it is not that strange that many institutional investors have put (geo) politics at the top of their worry list for 2018. In which areas could we see actual crises break out?
The geopolitical worries that investors have for 2018 do not come as a surprise. The abovementioned global trends are increasing the likelihood of instability. These developments translate into various regional potential pockets of (geo) political turmoil:
In the United States, Washington can become even more chaotic.
Europe still struggles with major internal problems as external and negative forces gather momentum.
Latin America is on the eve of political shifts.
The Middle East is increasingly the arena for proxy wars between regional and global great powers.
North Korea will continue to hang over the world like a dark mushroom cloud.
To sum up, the fact that geopolitics is the main worry for the markets in the coming year is not exclusively due to the absence of economic thunderclouds on the horizon. There actually is a range of political factors that could disrupt the markets in 2018, also considering the positive (some will even say lazy) stance of many market parties. When a sunny spell is anticipated, a rain shower can abruptly change the mood.