Thematic Blogspot : Geopolitics and the economy: What are the risks?

Should investors be worried?

Buttonwood underlines many equity markets are at very high levels despite geopolitical risks; arguing though that markets would perhaps have been even higher in the absence of those geopolitical factors.

Though, Mouhammed Choukeir argues that current geopolitical conflicts may have substantial impact on the markets.

First, the Ukraine conflict has made the German stock market bear significant losses, and European stocks are thought to be particularly vulnerable too.

Second, regarding the Israeli-Palestinian conflict, beyond the local economic implications, can have tremendous impacts on the markets as the 1970’s oil price surge reminded us, leading to double digit inflation, recession, and financial assets crash.

Third, the Islamic State is a geopolitical and economic threat too. Beyond reshaping economic organization and modifying bilateral trade and alliances, it also impacts international relations. As main powers decide or not to intervene in the region, this can lead to further diplomatic disagreements hence raising uncertainties; or, on the contrary, as Ian Bremmer shows, lead them to agree on an intervention, therefore forcing them to focus on specific sectors development such as military equipment, technology and telecommunications.

However, according to Jan Dehn, the geopolitical risks which arised from the Ukrainian conflict and from the Middle East conflict are country-specific and fairly localized, so that the market do not pricethem altogether. Besides, Olivier Blanchard (IMFDirect) says that geopolitical risks are here, though not having global macroeconomic repercussions yet.

Time plays a part in geopolitics’ influence on the economy

For Mouhammed Choukeir, geopolitical risk rarely affects markets over the medium to the long-term. However, as Gideon Rachman highlights in a Financial Times article, geopolitical stability over time can play a part : for him, investors' apparent insouciance regarding current geopolitical risks may be due to the past 30 years’s considered geopolitical improvement. Tina Fordham agrees with the idea, highlighting a perception lag due to investors and money managers being used to a prosperous and peaceful period over the last decades.

Besides, a Deutsche Bank Markets Research argues that global geopolitical tensions are not temporary but rather structural to the current world system, as it defends that a single superpower world dominance brings relative structural geopolitical stability while the periods of multiple and competing great powers are times of high geopolitical instability. In this context, they consider that only since 1990 have the Unites States become a dominant superpower, which corresponds to a period of prosperity and investor exuberance. The emegence of China and the fact that the US now represent less than 20% of global GDP (believed to marks the global dominance threshold) questions the future of geopolitical stability.However, Buttonwood argues that « this time is not different but normal » with rival powers competing for resources and influence, bringing tension and therefore potentially disrupting trade and investment.

Geopolitical turmoil does not always damage the markets.

Kleinwort Benson’s CIO blog reminds us that though geopolitical turmoil is irrefutably present today, history refutes the hypothesis that geopolitical tensions always have negative impacts on markets. He shows for instance that the Cuban missile crisis of 1963, the Vietnam War announcement in 1964, the Six-Day War of 1967, the soviet invasion of Afghanistan in 1979, and the US invasion of Iraq in 2003 have all lead to increases on the S&P 500 and not, as one can first expect, losses. The Arab-Israeli war of 1973 and the 9/11 attacks are counter-examples though.

However, beyond the S&P 500’s performance, those episodes (particularly the invasion of Afghanistan) have indeed brought economic and financial turmoil, especially on gold (as it is considered as a secure alternative-to-the-dollar asset in times of international tensions) as well as oil. Indeed, as Andrew Topf reminds, gold and oil are believed to be negatively correlated to dollar as the three of them would be considered as international reserve “currencies”.

Though, Mouhammed Choukeir believes that geopolitical factors are rarely (if ever) the unique cause for market turmoils, taking the example of the Bretton Woods system collapse as a complementary explanation for the Arab-Israeli War of 1973’s impact on oil embargo and inflation.

Do geopolitics reshape the economy?

Ian Bremmer highlights states’ increased role in the economy in times of geopolitical tensions, arguing that risk-averse governments are more focused on political stability than on economic growth, which may make lead them into taking take economically non-efficient decisions. First, by supporting or “punishing” companies depending on how they respect government’ political goals.

Second, because sanctions can have bring long-lasting damages (if not bankruptcy) not only on the targeted states’ companies, but also, as a ripple effect, on national companies.

Third, because of states’ increased desire to control borders in times of uncertainty, as underlined by a Stratfor article.

Fourth, because geopolitical conflicts could lead, as we previously suggested, to states shifting their priorities to specific security-related war-economy sectors, and reallocating budget from other sectors to defense for instance.

On the contrary, some argue that other factors than geopolitics are taken into account when evaluating global risks. JP Morgan strategist Tai Hui believes that investors care more about economic recovery (especially in the United States, China and Japan) than geopolitics in their risk appreciation. Brian Bremner and Simon Kennedy (Bloomberg) argue that geopolitical risk are undervalued and volatility suppressed thanks to the Fed, ECB and BoJ’s expansionary monetary policies.

Focus on European Union geopolitics.

Ian Bremmer argues that different geopolitical tensions inside the Eurozone may impact its economy, in a context of rising contestation. Indeed, anti-EU political parties’ increasing popularity undermines the ability for governments to conduct economic reforms. Besides, tensions rises between Eurozone members, dividing Europe into “core” and “peripheral” countries, therefore also hampering EU policies. Buttonwood believes that the re-emergence of nationalisms draws new economic risks, especially discouraging international investment.