Thematic Blogspot - Geopolitics and the economy: What are the risks?
According to the latest IMF World Economic Outlook, geopolitical conflicts are weighing down on economic prospects—including through the risk of higher-than-expected US long-term rates, tightening the financial conditions for other market economies (IMF). For Mike Scott, geopolitical risks are at the centre stage of 2015 risk agenda. The list of potential risks is long: the Ukraine-Russia conflict, the Israeli-Palestinian conflict, the terrorist acts of the Islamic State and a possible coordinated response (Ian Bremmer).
Some analysts, e.g., Jim Puzzanghera, argue that rising geopolitical risks – in Ukraine or in the Middle East - have eroded consumer and business confidence, impacting the European economic growth forecast and international financial markets. This was underlined by Mario Draghi who declared “heightened geopolitical risks” which “may have the potential to affect economic conditions negatively, including through effects on energy prices and global demand for euro area products.”
How is the geopolitical context affecting the economic outlook?
Should investors be worried?
Patrick Artus (Natixis) argues that high geopolitical risks are likely to result in economic impacts - as a rise in commodity prices - and financial effects - such as increased volatility and risk aversion, representing a significant threat to growth. Nonetheless, these effects will be mitigated by the abundance of market liquidity exempt from geopolitical risk premia. Brian Bremner and Simon Kennedy (Bloomberg) argue that geopolitical risks are undervalued and volatility suppressed thanks to the Fed, ECB and BoJ’s expansionary monetary policies.
Buttonwood underlines that many equity markets are at very high levels despite geopolitical risks—yet possibly undershooting due to geopolitical factors. 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. Mouhammed Choukeir argues that current geopolitical conflicts may have substantial impact on the markets through a confidence effect. However, Jan Dehn sees most of those risks as country-specific and fairly localized, so that the market does not price them altogether. Olivier Blanchard (IMFDirect) also says that geopolitical risks are here, though not having global macroeconomic repercussions yet.
Looking at past episodes (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), Kleinwort Benson refutes the hypothesis that geopolitical tensions always have negative impacts on markets—all these episodes led to increases in the S&P. Further, Mouhammed Choukeir believes that geopolitical factors are rarely (if ever) the unique cause for market turmoil, 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.
But the impact can be market on specific market segments, such as gold (viewed as a refuge asset) and oil—all playing, with the US dollar, the role of international reserve assets according to Andrew Topf.
What is the time horizon of geopolitics’ influence on the economy?
There is a debate over whether geopolitical risks are structural or conjonctural.
Positive hysteresis from past stability. For Mouhammed Choukeir, geopolitical risks rarely affect markets over the medium to the long-term. However, as Gideon Rachman highlights in a Financial Times article, geopolitical stability over time can provide an upside and investors' apparent insouciance regarding current geopolitical risks may be due to the past 30 years’ considered geopolitical improvement. Tina Fordham agrees, highlighting a perception lag due to investors and money managers being used to a prosperous and peaceful period over the last decades.
From single- to multiple-power system. Deutsche Bank Markets Research argues that global geopolitical tensions are not temporary but rather structural to the current world system. A single superpower world dominance brings relative structural geopolitical stability while periods of multiple and competing great powers are times of high geopolitical instability. While the 1990s were characterized a period of prosperity and investor exuberance with the Unites States as a single dominant superpower, the emergence of China and the fact that the US now represents 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.
Do geopolitics reshape the economy?
Ian Bremmer highlights governments’ increasing 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 to 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 can lead to states shifting their priorities to specific security-related war-economy sectors, and reallocating budget from other sectors to defense for instance.
Geopolitics competition deeply affects economies, potentially leading to trade disruption (Mark Leonard and Gregory R. Copley’s argument on China’s strategy “to replace the United States as the dominant global sea power”). The impact can be substantial (for example, Michel Foucher estimates the impact of that China’s maritime strategy led to a fall in exports by Japanese companies).
Focus on European Union geopolitics
Ian Bremmer argues that different geopolitical tensions outside and inside the Eurozone may impact its economy, in a context of rising contestation.
Mark Leonard demonstrates that the economic sanctions resulting from the Ukrainian conflict have not only hurt the punished country (Russia) but also the European Union or the United States—as a double-edged sword. According to Nouriel Roubini, the conflict between Russia and Ukraine is affecting growth and exports in Germany and throughout Europe. The Russian counter-sanctions banning food imports led to a decrease in demand, worsening the EU economic recovery.
Inside the European Union, anti-EU political parties’ increasing popularity undermines the ability for governments to conduct economic reforms. Tensions between Eurozone members also hamper European policies. Buttonwood writes that the re-emergence of nationalisms draws new economic risks, especially discouraging international investment.
By Marie Rouget & Charlotte Majorel
Download this article (.pdf)
To further explore some of the topics discussed in this article, please click on the tags below:
