Ok, everyone knows the geopolitical backdrop is hopelessly fraught, right? Right.
That’s thanks in no small part to the fact that the European populist revolt (catalyzed as it was by political opportunists who seized upon the flood of refugees fleeing the war-torn mideast to play on the fears of disaffected sectors of the electorate) made the trip across the Atlantic and manifested itself in Donald Trump, who took the xenophobia inherent in the message of Marine Le Pen, Brexit, AfD, and Geert Wilders, modified it for relevance to U.S. voters, slapped his signature tackiness on it like it was a goddamn Trump-branded hotel, then sold it to gullible voters just like he sold mail order steaks to morons and fake college degrees to would-be real estate moguls.
The rise of nationalism and populism over the past couple of years has been tethered to a backlash against globalization, which the political opportunists mentioned above have cast as the proximate cause for everything that ails the Middle Class in developed economies.
In the developing world, the “intrusion” of foreign ideals creates a backlash against societal backwardness. The thirst for modernity among the masses very often engenders brutality from the powers that be in order to slow the pace of modernization to the extent government believes the modernization push imperils their grip on power. It’s also fertile ground for extremism as radicals paint modernization as an effort by foreigners to impose their beliefs and culture on people who don’t want it. Military occupations by Western forces only reinforce that message and serve to legitimize it among those who are vulnerable to radicalization. In Syria and Iraq, that radicalization got turned up to a Spinal Tap-ish “11” in ISIS, whose brutality put them in a figurative and literal league of their own, leading directly to conflict not only between the group and Shiite forces/government actors, but also to conflict between ISIS and competing Sunni radicals.
The ensuing violence in Iraq and Syria ironically led to the refugee crisis that fed into the message being pushed by the populists in Europe and later, into Trump’s own brand of noxious nationalism. In this way, the demonization of globalization and multiculturalism has created a truly toxic societal backdrop both in the developed and the developing world.
It’s worth noting that China is navigating its own path through the process of coming to terms with the inevitable push towards globalism, something they’ve managed to pull off with varying degrees of success, although not without nationalist overtones and periodic lapses into the draconian.
Thanks arguably to nearly a decade of monetary accommodation, economies and especially markets have been largely immune, as some $20 trillion in liquidity injections have served to inflate bubbles in financial assets and, although perhaps with more of a lag than economists expected, the wealth effect created by those bubbles has trickled down, manifesting itself in real economic outcomes. The imbalances created along the way are another story.
As Barclays writes in a sweeping new piece focused on geopolitical landmines, “the present risk environment is characterized by remarkably low economic risks but with a geopolitical landscape that is littered with an historically large number — by one measure, the highest since World War II — of international conflicts with high potential to affect the global economy and markets.” Consider this, from the note (which is nearly three dozen pages long):
Figure 1 quantifies the level of current non-economic risks relative to history. The Caldara and Iacoviello Geopolitical Risks Index (GPR) measures those risks by text-searching 11 international newspapers for explicit discussion of geopolitical risks, nuclear tensions, war and terrorist threats, and coverage of realized military conflict or terrorist acts. Although recent readings are shy of peak periods of global conflict, the April 2018 reading is in the 90th percentile. The persistent trend rise in the index since the early 2000s is more to the point of our analysis: the five-year moving average (light blue) now is at its highest level since the end of World War II.
The trend rise in risks over the past decade and a half reflects more threat than action at this point. The GPR can be divided into two component parts: news associated with threats or tensions, and news related to acts of geopolitical conflict (Figure 2). It is an unprecedented rise in the trend of threats that is responsible for the rise in the overall index, not actual conflict, which remains historically low. It is possible that this may reflect increasing news sensationalism. But, the GPR threats index has led the acts index over the 120 years covered by each, suggesting that the sustained build-up in geopolitical tensions ultimately will be released. We suggest below why there is an increased likelihood that relief may be more abrupt than recent history would suggest.
Ok, so how did we get here? To answer that, Barclays cites three factors:
- and “policy gamblers”
Just to be clear, they have put what certainly appears to be a ton of effort into this piece and it would be impossible to do it justice here, so I’ll just excerpt a scant few passages from the sections on those three factors.
Globalisation has at once integrated the global economy and facilitated international dialogue, but at the same time it has brought distinct cultures and self interests into stark conflict, both between countries and within. By at least the early 1990s, as the Cold War ended, academics began to notice trends in globalisation that they forecast would lead to heightened cross-cultural conflict and within-state political tensions. Most famously, the late US political scientist Samuel P. Huntington wrote in 1993 that the end of the Cold War’s bipolar international alignments implied that henceforth the ‘great divisions among humankind and the dominating source of conflict [would] be cultural.’
Huntington’s predictions, though controversial, have withstood time well and garnered support both from history and further study. Numerous academic analyses have debated the magnitude but generally acknowledged that globalisation contributes to international conflict as non-Western states reflexively re-embrace their distinct cultural differences as they modernise and as the shadow of Western dominance recedes. Although the Korean conflict ultimately is a relic of the Cold War, it, Iran’s confrontation with the West (including Israel), Russia’s conflicts with the West on its borders, Syria and elsewhere, and China’s wider definition of its territory all reflect Huntington’s original fault lines. While there also is evidence that globalisation may help to temper international conflicts by building economic and cultural ties, the net effect appears to have increased the potential for cross-cultural friction.
A second factor that has led to the build-up of geopolitical tensions has been embedded ‘incrementalism’ in international institutions and most domestic political structures. Incrementalism is a form of governance and policymaking put forward in the 1950s by the late American political scientist, Charles Lindblom in his aptly titled paper ‘The Science of “Muddling Through”’. Lindblom and his academic disciples characterized US and international policy institutions as structurally incremental in process, and advocated policymaking based on incremental adjustments as a deliberative process of negotiation between competing polities. But as pointed out by subsequent researchers, incrementalism tends to default toward preservation of the status quo, or ‘kicking-the-can’ solutions, that allows tensions to build without incremental adjustment towards a long-run solution. The tendency to ‘kick the can’ comes both from the structure of institutions and from a behavioural incentives of incumbent political leaders to choose status quo solutions. Several of the flashpoints listed earlier owe their increasing near-term relevance to previous ‘kick-the-can’ international policy solutions.
On ‘Policy gamblers’
Into this long history of incrementalism, the 2016 US election has thrown into the lead role of international diplomacy and ‘world policeman’ a consummate risk taker whose career has been made in high-risk/reward investment projects rather than political incrementalism. One of the most common words associated with US President Trump’s policy approach is ‘gamble’: with respect to his signature tax plan, his approach to congressional negotiations on healthcare and budgets, his immigration policy, his trade policy, his brinksmanship with North Korea, his stance on Iran and the JCPA, and his strikes on Syria. In each of these areas, President Trump has taken an aggressive stance and shown an unusual willingness — for a policymaker — to position for or choose a high-stakes resolution over gradualism.
Coming at a time when the world’s geopolitical risks tree is laden with fruit ripened by incrementalism, President Trump’s arrival implies higher risks of the fruit dropping to the ground or being picked; ie, we now face greater risks of nearer-term and more extreme resolutions than the last few decades’ historical experience would suggest.
Notably, Barclays does not confine the discussion of “policy gamblers” to Trump. They also cite Mohammad bin Salman and the Crown Prince’s efforts to purge rivals (more here, here, and here, to cite a few of our dozens of posts) and his vaunted “Vision 2030” plan which, stripped to its core, aims to reshape Saudi Arabia economically and culturally and recast the Kingdom’s international image. Also mentioned are Kim Jong-Un and Putin.
You might recall that we spent a good bit of time discussing the “policy gamblers” idea last year in an amusing post called “The Austin Powers World,” which we’re going to reprint below because it seems particularly relevant to this discussion.
Ok, moving along, Barclays raises the bar in terms of analysts attempting to quantify the probability of negative market outcomes associated with geopolitical turmoil. And they’re not shy about communicating their ambition. There is a section in this note entitled “How likely is ‘something bad’?” In it, the bank attempts to assign probabilities to “something bad happening” in the context of the following 13 flashpoints:
- Military action in Korea
- US confrontation with Iran over nuclear program
- Syrian war escalation
- Kurdish independence
- Direct conflict between Iran and Israel
- Saudi Arabian upheaval
- Iranian upheaval or civil war
- Venezuela fails as a state
- Russian conflicts with border countries and West
- Confrontations over South and East China Seas sovereignty
- US Executive/Legislative branch conflict
- FAANGs regulation or anti-competitive sanctions
- Trade war
Again, this is an ambitious exercise and here’s Barclays explaining how to use their model:
Figure 3 provides our parameterization of the probability that ‘something bad’ happens to disrupt broader markets given 13 geopolitical risks. The table allows the reader to assess the probability that at least one among these risks will occur based on his or her own subjective judgements regarding the average unconditional likelihood of any of the tail risks (columns) and the average conditional probability between the risks (rows). For instance, if one assumes that the average unconditional probability of any tail risk — ignoring potential correlations between them — is 3%, and the average magnitude of conditional probability between correlated risks — the probability by which one event is more or less likely given another event has occurred — of 10%, the aggregate probability of ‘something bad’ is 31.1%, or roughly 1 chance in 3.
The bank draws two conclusions from that table. To wit:
- the probabilities of ‘something bad’ are decreasing in the magnitude of assumed conditional dependency; and
- assuming even small average unconditional likelihoods of tail risks — between 1% and 5% — the likelihood that at least one occurs is not small: all but two cells have probabilities over 10%, and just over half the table ranges between 31% and 64%, roughly chances of between 1 in 3 and 2 in 3.
If you can’t decipher that, the real takeaway comes when the bank reduces point two to the simple observation that “the relatively high likelihood that ‘something bad’ occurs, is due to the sheer number of plausible geopolitical risks now present.”
How prepared is that market for “something bad”? Well, Barclays takes that up as well, but for the sake of salvaging something in the way of brevity, we’re going to leave that for a separate discussion, especially considering it calls for bringing in multiple related discussions about the hierarchy of vulnerability across asset classes and the extent to which recent spikes in equity volatility have had a certain “made in the U.S.A.” character to them.
For now, just know that if it seems like there’s a lot going on geopolitically, that’s because there in fact is.
While any assessment of the extent to which the geopolitical backdrop is more or less fraught than at other times in history is inherently subjective, what Barclays’ analysis suggests is that we are indeed living in turbulent times by (almost) any standard in modern history.
From “The Austin Powers World”, as originally published October 8, 2017
We spend quite a lot of time in these pages marveling at the extent to which the current political (and geopolitical) landscape is characterized by something that approximates sheer absurdity.
It’s everywhere you look. It’s like something out of a comic book. Or maybe a fusion of a James Bond film and an Austin Powers sequel. There’s real danger but at the same time, the central figures are so laughable that it’s difficult to accept it as reality.
Donald Trump’s administration is a circus. And almost in the literal sense of the word “circus.” He treats critical government appointments (and staffing decisions in general) like a high stakes versions of The Apprentice. He engineers high profile feuds with entertainers, athletes, and other celebrities that serve to distract America from the policy train wreck unfolding behind the scenes. He wears burnt-orange face paint to the U.N. General Assembly. And his attitude towards foreign policy is so cavalier that it would seem irresponsible even if he were playing a video game.
Meanwhile, other global actors have become caricatures of themselves.
In Turkey, Erdogan has descended into something akin to dictatorial madness and sounds increasingly genocidal when it comes to the Kurds both in his own country and in Syria and Iraq.
The Saudis have decided to let women drive, a step in the right direction, but as a reminder, the ideology espoused by the likes of ISIS and al-Qaeda is institutionalized in the monarchy. In short, America’s Sunni allies are supporting the very same Sunni extremist groups that are attacking Western capitals. The hypocrisy there reached peak absurdity earlier this year when Donald Trump, Saudi Arabia’s King Salman and Egyptian President Abdel Fatah al-Sissi all stood around in the dark grasping a giant glowing orb in a gesture of unity to celebrate the opening of the Global Center for Combating Extremist Ideology in Riyadh. And yes, you read that correctly, they opened a “Global Center for Combating Extremist Ideology” in Riyadh or, in other words, they are opening a global center for combating extremist ideology in the global center for promoting extremist ideology.
Just to cement the Saudi stereotype, last week found King Salman confused about what to do when the golden escalator that descends from his plane broke:
Saudi Arabia king's golden escalator stairs got stuck coming out of his airplane into Moscow in Russia yesterday. https://t.co/xGKYtSvEUs
— Anna Massoglia (@annalecta) October 5, 2017
In the UK, Theresa May has become a victim of the Brexit farce — her speech earlier this week, complete as it was with publicity stunts, coughing fits, choking, and letters falling off the wall, was in many ways emblematic of the plight of her people 15 months on from the referendum.
Marine Le Pen’s swastika-shaped shadow still hangs over French politics despite her election loss and her ideological counterpart in the Netherlands is a living, breathing cartoon.
There’s Putin, in Russia, but more amusing are his underlings — the deadpan Sergei Lavrov and the ridiculous Maria Zakharova, who looks like a picture you would see next to a dictionary entry for “stereotypical female Russian villain.”
Even Kim Jong-Un, the poster child for comedic heads of state, has become a caricature of a caricature of a caricature (the Trump spat has made him a more ridiculous version of himself and he was already a more ridiculous version of his father).
Less ridiculous, but still cartoonish in their own way are Macron in France and Trudeau in Canada. Macron, for instance, recently had himself winced down from a helicopter onto a nuclear submarine where he spent four hours underwater to “show his support for the country’s naval fleet.”
Meanwhile, Trudeau takes pictures of himself laughing with pandas and just two weeks ago showed up at a Bloomberg Global Business Forum wearing Chewbacca socks.
Against this backdrop, Angela Merkel appears increasingly isolated as the last remaining bastion of stability, sanity, and/or normalcy in a world gone mad.
Indeed, there’s a strong argument to be made that the only reason she ran again for chancellor was because she was afraid that if she didn’t, the entire world might fall apart.
Immanuel Wallerstein recently described the current state of the world as “chaotic uncertainty.” To wit:
Are you confused about what is going on in the world? So am I. So is everyone. This is the underlying and continuing reality of a chaotic world-system.
What we mean by chaos is a situation in which there are constant wild swings in the priorities of all the actors. One day, from the point of view of a given actor, things seem to be going in a way favorable to that actor. The next day the outlook looks very unfavorable.
Furthermore, there seems to be no way in which we can predict what position given actors will take on the next day. We are repeatedly surprised when actors behave in ways that we thought impossible, or at the very least unlikely. But the actors are simply trying to maximize their advantage by changing their stance on an important issue and thereby changing the alliances they will make in order to achieve that advantage.
The world-system has not always been in chaos. Quite the contrary! The modern world-system, like any system, has its rules of operation. These rules enable both outsiders and participants to assess the likely behavior of different actors. We think of this adherence to the rules of behavior as the “normal” operation of the system.
It is only when the system reaches a point in which it cannot return to a (moving) equilibrium that renews its normal operations that it enters into a structural crisis. A central feature of such a structural crisis is chaotic uncertainty.
Fair enough. But it would certainly appear that part and parcel of the chaos is the presence of rampant irrationality and excessive eccentricity.
Allow us to leave you with this instant classic snapshot from Trump’s meeting with Abe earlier this year. How confident do you feel?