Dark political clouds are gathering

Published: Sep 2014

Banks and other research houses increasingly agree with our assessment that geopolitics is becoming important. They caution that the markets do not pay enough attention to geopolitical risks. Deutsche Bank warned that the “markets are in general taking far too benign an approach to geopolitical risk.” Other banks – for example, Nomura and BNP Paribas – are also focusing on the abyss between the geopolitical reality and the risks that the markets are pricing in (which are often mispriced to boot). The French bank wrote that it is “concerned that geopolitical risks are slowly but surely on the rise, and that markets have grown complacent about this over the years.”

Hotbeds and minefields are concentrated in three regions: the Middle East and North Africa (MENA), Ukraine and Russia, and Asia. With reference to MENA, several experts have drawn parallels with the Thirty Years’ War in Europe (1618-1648). Many states are weak and unable to control or secure their own territories. Meanwhile, a handful of relatively powerful nations with a clearly defined identity – including Iran, Saudi Arabia, and Turkey – are competing for primacy. At the same time, militias and terrorist organisations are multiplying and gaining ground, as borders crumble.

Age of Grievance

At first glance, there is no direct link between the Middle East and the Ukraine. Professor of National Security Strategy Michael J. Mazarr takes a different view. He refers to “the Age of Grievance”. Many groups and communities that pose major security risks, feel displaced and alienated from the liberal international economic world order. Dissatisfaction, pain and fear can translate into violent action – partly to overcome burning humiliation and regain some pride. This motivates many jihadists but also the rebels in Ukraine. Of course, puppet masters like Putin are good at exploiting such emotions. At the same time, geopolitics is here to stay, as evident from the games that Putin plays.

This creates a dangerous brew of power politics, national interests, and feelings of disenfranchisement and resentment among large sections of the population. Especially relevant is that state borders are not always identical with the boundaries between nations.

The existing disaffection and insecurity are exacerbated by the excrescences of globalisation. The process has pulled the rug from under large groups of people who feel they have no legitimate channels to improve their situation. The sociologist Saskia Sassen speaks of global marginalisation. The root cause is that the interests of political elites and the business sector are increasingly entwined. Politicians see economic growth as the ultimate goal which can be achieved if they get into bed with the global business sector. They are often convinced that what is good for business is good for growth and thereby, implicitly, for the population at large. To some degree this may be true but, increasingly, the situation tends to be one-sided. One could speak of the denationalisation of nation-states.

Chart 1: Volatility is historically low. Is this the calm before the storm?
Chart 1: Volatility is historically low. Is this the calm before the storm?

Source: Thomson Reuters Datastream/ECR

Someone like Putin is a product of (and uses) the opportunities and changes brought by globalisation, the marginalisation of large groups, and the “Age of Grievance“. He exalts Russia’s past as a major (or even super) power and highlights the evil intentions of the West as he plays them off against Russia’s traditions, patriotic and nationalistic tendencies, and search for a national identity. In addition, he is claiming the right to protect Russian speakers abroad. It is blatantly obvious that he interprets this “right“as he sees fit and is not afraid to stoke geopolitical tensions.

The geopolitical risks in Asia are less pressing but could have unsettling implications (the region contains four nuclear powers: China, India, Pakistan, and North Korea). The main risks are connected to old-fashioned power politics. The skirmishes between India and Pakistan are of an ongoing nature and there is always the possibility that the North Korean regime will implode or that it will lash out in petulant anger. However, these risks have existed for decades and the markets have learned to live with them. In the past years, the focus has shifted to Asia’s territorial disputes, which involve countries such as Japan, South Korea, China, Malaysia, the Philippines, and Vietnam.

Geopolitical hydra

Geopolitical tension (and its effect on the financial markets) will likely increase rather than subside. To a large degree, the developments in MENA, Ukraine and Russia, and Asia are symptomatic of deep-seated and wide-ranging trends that cannot easily be reversed – global marginalisation, the “Age of Grievance”, weakening nation states, and so on. In 1975, three renowned academics and advisers (operating under the moniker The Trilateral Commission) reported in “Crisis of Democracy” that citizens had ever-higher expectations of governments whereas the states themselves were less and less equipped to meet these expectations. Western governments, in particular, ignored the existing dangers. Security was no longer a priority and complacency was a real risk. They predicted that it would become harder to tackle social or economic problems and that people would lose confidence in the state.

It seems that the Trilateral Commission got it right all those years ago. Today, the West is weakening and the emerging powers are flexing their muscles. The BRICS are setting up a New Development Bank (NDB) as well as a fund to help countries in emergency situations. This Contingency Reserve Arrangement and the NDB are supposed to challenge the dominance of the World Bank and the IMF. However, the financial scope of the plans is relatively limited, while the BRICS have far more reasons to disagree than to concur. We think the BRICS bank has yet to prove itself and that the impact is unlikely to live up to the hype. On the other hand, the balance of power between the West and the emerging economies is shifting; so much is clear. We seem to have arrived at some sort of “twilight zone“. The West lacks the conviction, capabilities, and desire to bring the world “to heel“. At the same time, it is unwilling to share power and influence with the emerging powers. In turn, the latter still lack the clout to overrule the rest should they so want. Theoretically, in a world without a broadly accepted police force or fire brigade, minor quarrels and smouldering fires can quickly grow into earth-shaking crises.

Chart 2: The balance of power between the West and the emerging economies is shifting; so much is clear
Chart 2: The balance of power between the West and the emerging economies is shifting; so much is clear

Source: Thomson Reuters Datastream/ECR

There does not seem to be an efficient method to fight the flames (instead of fanning them). Real solutions are few and far between. At best, it may be possible to manage the potential emergencies but effective geopolitical crisis managers are rare. In other words, this will be a hell of a job. Therefore we strongly recommend that the markets focus on geopolitical developments. Recently, a French magazine referred to the Somalisation of the world. This may be an exaggeration but we could do worse than heed the warning words of former US National Security Adviser Zbigniew Brezinski: “We are losing control of our ability at the highest levels of dealing with challenges that many of us recognise are fundamental to our well-being. And yet we cannot muster the forces or generate the leadership to deal with them….there is enormous turmoil and fragmentation and uncertainty – not a single central threat to everybody, but a lot of diversified threats to almost everybody.”

It is high time that investors and businesses become aware of the implications of various geopolitical risks. Many fund managers have been saying that asset prices were priced for perfection. Therefore mounting geopolitical risks could be part of the multilayered trigger causing a new bear market.

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