Geopolitics meets markets

Emerging markets debt expert Timothy Ash explains the difficulty balancing geopolitics and markets while describing why the China-US relationship is an anchor point for global geopolitics.

The perception that geopolitical risks are increasing is the consensus view these days. Events in recent weeks in the Middle East have only served to reinforce this perspective. Getting geopolitical calls right – or at least not being on the wrong end of such calls – is now seen as critically important for businesses.

The importance of geopolitics for business and markets was laid bare in 2022, when many companies made the wrong call on the Russian invasion of Ukraine and suffered big P&L hits. Many Western companies were left holding assets subject to sanctions or had assets stranded in Russia. They were either unable to offload these or were subject to punitive sale conditions, which were imposed by the Russian state.

Misreading Putin

With hindsight, Western businesses had been misreading Russia under Putin for years – not just in 2021-22 – by adopting a far-too-optimistic view of geopolitical risks around the country. The problems were long in the making, and perhaps by 2022, it was already too late for many to exit.

On the Russia call, in particular, there were many explanations for Western businesses getting it wrong. These range from ignorance or arrogance, wishful thinking (given many of these businesses were over-committed already) or failing to read the warning signs from their governments to a corrupted information set (as Russia infiltrated Western institutions giving the messages), viewing Russia through the wrong prism and assuming Putin was logical, like us, and not a brutal authoritarian with an obsession with Ukraine and in putting right what he saw (incorrectly) as the injustices done to Russia in the past. If one managed to get into Putin’s mindset, it was logical that he went for a full-scale invasion of Ukraine in 2022.

Geopolitics is difficult to get right

Here lies a big problem – geopolitics is important but difficult for businesses to get right. Partly, this reflects the essence of geopolitical risk. The dictionary definition would likely suggest it is the interplay between foreign affairs, defence, security, and the economy and markets. The problem therein is that it is a multidisciplinary subject. Diplomats or security types might be able to figure out one dimension – whether a war or invasion is likely to happen or if sanctions are likely – but they lack the economics, business or market experience to determine the economic or market impact. Similarly, someone coming at it from a business or market angle might be able to calculate the market impact of a geopolitical event fairly accurately but might find it hard to determine whether an event will happen or attach an accurate probability to that event.

Notably, many banks, investment firms and businesses hire ex-diplomats, generals and admirals to help them with understanding geopolitical risk. However, they might not be best positioned to determine the impacts described above. Adopting a holistic approach might be best to understand what you don’t know - the infamous Rumsfeld ‘known unknowns’.

The problem with the perception that geopolitical risks are rising is admitting that the world is a horrible, unsafe, and uncertain place, whereby it is easy to go into paralysis and do nothing. But by using a holistic approach, it is possible to understand risks around geopolitical events or threats, figure out probabilities, and then try to price risk.

Geopolitical risk is not a new concept

The reality is that geopolitical risk has been around since history began. If you had been at the end of the sword of the Imperial Roman expansion, Viking raids on the West coast of Europe, the Norman Conquest of Saxon England, or Western colonialism, you would have well understood the downsides of geopolitical risk, albeit you might not have called it that. Fast forward to World Wars One and Two, and it is evident that geopolitical risks were there but not labelled as such. It was more like ‘imperialism’, ‘colonialism’ and ‘war and conquest’.

However, changes in recent years perhaps stands in some contrast to years back in very recent memory. Partly, these reflect the relative geopolitical calm, or perhaps easier geopolitical setups to figure out up until maybe the Global Financial Crisis (GFC), or thereabouts, possibly pushing out to the Arab Spring around 2010/11.

First, the Cold War is when you have two blocks and a non-aligned crew trying to stay beyond the reach of those blocks. But the NATO and then the Warsaw Pact blocks limited the number of geopolitical players to figure out, with a near score of countries in each block, while others such as the Gulf states sought safety under the wing of the US. NATO and the Soviet-dominated Warsaw pact engaged in brutal proxy wars across the globe.

These were near fatal for those caught in those conflicts, and some of these, for example, the Cuban missile crisis, or later the Greenham Common missile crisis (we only recently came to understand how close we came to nuclear destruction in the 1980s), came close to global catastrophe. But guide rails were provided by the ultimate deterrent: the prospect of mutual nuclear destruction. The core relationship, or geopolitical risk, was around the Moscow-Washington relationship, with fewer moving parts to figure out.

The domination of US exceptionalism

The collapse of the USSR heralded a period of a unipolar world dominated by the US and its exceptionalism. The US was ascendant, even triumphal, for beating Communism, or so it thought. Its military machine was able to impose peace, or resolution, through the exercise of might in the first Gulf War, then Kosovo. What the US wanted, it usually got, at least when it knew what it wanted and was focused on delivery therein. So that meant EU and NATO enlargement in Europe, amongst other things, and those made the recipients feel safer, suffice that they went out and spent the peace dividend. Ironically, this underinvestment in defence arguably laid the foundations for the current crisis in relations with Russia.

The US’ confidence and security in its global domination encouraged it to surrender some sovereignty via its support for multilateralism and hand-in-hand globalisation. The assumption for then sub-peer rivals, Russia and China, was that by bringing them into the systems dominated by the US, global markets and trade, they would become like us, and all would benefit. We would all be wealthier and more secure as a result. But from a geopolitical risk perspective, the simplicity back then was figuring out what the US wanted first, and events followed an essentially US-driven course.

The comeback here would be 9/11 and how geopolitical practitioners got that wrong. Perhaps there was too much complacency. But in those early noughties, the world was still pretty optimistic, joined up and easier to figure out. There was a remarkable international cooperation in support of the US, post 9/11, in particular with Putin (remarkably now) allowing the US military to use bases in his backyard in Central Asia to hit Al Qaeda in Afghanistan. Later, the unified response to the GFC spurred the creation of the G20 and counter-terrorism entities like FATF.

What went wrong?

Perhaps there was too much of a good thing and the US and the West became complacent, even arrogant. The failed US intervention in Iraq in 2003 was something of a turning point. The cost proved to be a confidence shock to the US, turning it towards isolationism. The perception of it as ‘invincible’ began to crack. The GFC added grit to the mill by creating a global recession.

Higher unemployment and many of the policies in response (such as quantitative easing) increased global inequality. The toppling of Saddam and the economic shock waves of the GFC fanned the Arab Spring and Western indecision on Syria and Libya, combined with transport, telecommunications and social media revolutions, with global inequality spurring massive new migrant flows.

All the latter have fed the recent phenomenon of populism. As a result, the US stepped back, creating vacuums. New global and regional players stepped into the void, including Russia, Saudi Arabia, Turkey, India and China, adding to the complexity of the geopolitical mix. The relative decline of the US and the West (Brexit has poleaxed the UK as a global power) and the rise (and perhaps now decline) of China and the Global South are all part of this new mix.

The new multipolar world

A new multipolar world is the result, with added complexities for the geopolitical practitioner to figure out, including climate change, migration, trade wars (onshoring and trade autarky), social media, and technology (AI). There are now so many moving parts. However,  there are some stabilisers, at least for the time being.

The war in Ukraine has not created new blocks, or not just yet. China has not aligned and allied staunchly with Russia. Beijing seems to long for a return to the global order, harking back at least to the period before the Trump presidency, of globalisation and the multilateral world order that had allowed it to climb the global order of hegemony to within striking distance of the US. It has been eager to distance itself from Russia, not supplying Moscow with its wish list of military kit. This has forced Russia to resort to scraping the barrel, literally, by going cap in hand for drones from Iran and munitions from North Korea.

The US-China relationship

This US-China relationship is an anchor point for global geopolitics. The US appreciates China’s limits on Putin on the use of weapons of mass destruction, as were efforts at peace-making by China earlier in 2023, however rudimentary and Moscow-centred. We have seen both sides try to stabilise the relationship at the recent Biden-Xi summit in San Francisco. Whether this new stability in the US-China relationship endures a second Trump term is open to question. But it shows that the US and China have some common interests, such as preventing escalation in the war in Ukraine, avoiding war in Taiwan, and also de-escalating now in the Middle East, with both wanting to keep a cap on energy and commodity prices.

The US stepping back from its prior exceptionalist path has created a vacuum for others to fill. Still, when it comes to regional powers, they may be better placed to resolve conflicts in their region. Note here Saudi Arabia’s new efforts to improve relations with Iran, partially brokered by China. And let’s face it, after disastrous recent US interventions in the region, including in Iraq and Afghanistan,  direct Gulf-Iranian peace efforts couldn’t do much worse.

The Gulf region development focus

In the Gulf region, in particular, there is a new focus on economic development and reform, with countries as diverse as Saudi Arabia, Oman and UAE all having their economic development visions, from Vision 2025 to Vision 2030. Many of these are inclusive, encouraging infra-region investment now also extending to Iraq and Iran and bringing in China. Russia’s war in Ukraine initially created a surge in energy prices, but this built buffers in various wealth funds, which are now being deployed around the region to support development – from Iraq to Iran, Turkey, Egypt, Pakistan and Tunisia. Investment in economic development should improve living standards, thus reducing social and political pressures, which are ingredients for geopolitical risk.

The much-needed multilateral approach

The heightened geopolitical risks the world has been facing has given NATO has breathed new life and purpose despite once being described as “brain dead” by Macron. European countries, which had spent the post-Cold War peace dividend and many of which were freeloading on the US defence umbrella, now appear to better appreciate the risks from Russia and are increasing defence spending and better focusing and coordinating against the challenge.

Finally, climate change and its vast challenges can only be tackled through a multilateral approach, as seen now at COP28. Either we all co-operate or we suffer the effects of climate change, as seen from the ever-increasing climate crises we are experiencing, from wildfires to flooding. This is an existential threat to humankind that is plain to see – that said, given the amount of polluting munitions expended in the war in Ukraine, perhaps few would realise this.