Geopolitical risks for 2014
In 2014, big-picture economics are stable if not yet comforting. The EU has clawed its way out of recession. Japan has, improbably, discovered economic leadership. The economic performance of China’s new government is strong. And the US re- bound is sufficiently robust for the markets to shrug off New Year’s tapering resolutions.
But geopolitics is very much in play. The realities of a G-Zero order, a world of geo- political creative destruction without global leadership, are evident. There are tensions between China and Japan in the East China Sea, elite-level executions in North Korea, Russia flexing its muscles in neighboring Ukraine and beyond, and everyone fighting with everyone else in the Middle East (some things don’t change). All of which is changing the geopolitical map quite aside from the role of the world’s only superpower.
1 America's troubled alliances
2 Diverging markets
3 The new China
4 Iran
5 Petrostates
6 Strategic data
7 Al Qaeda 2.0
8 The Middle East's expanding unrest
9 The capricious Kremlin
10 Turkey
1. The US is not in economic decline. Despite Washington’s many challenges, investors continue to bet heavily on the US economy.
In fact, the country’s economic growth story is one of the most exciting in the world, driven by energy and food production revolutions; game-changing technologies in diverse sectors such as manufacturing, wearable computing, genomics, nanotech, and advanced military hardware (with plenty of crossovers among them); favorable demographics; and strong underlying political and social stability. A diminished middle class, poor public secondary education, and a badly functioning new healthcare system are embarrassing political leaders but will do little to undermine corporate investment and international support for the dollar.
There is, however, a notable decline in US foreign policy. Some of this is structural—too many increasingly influential countries with which to coordinate effectively; a distracted Europe led by Germany (with geo-economic and bilateral sensibilities) rather than a more geopolitically aligned UK and France; and emerging markets, particularly Russia and China, more willing to challenge US preferences abroad.
US’s second-tier allies (who increasingly feel like second-tier allies). That’s a much larger group, including Germany, France, Turkey, Saudi Arabia, the United Arab Emirates, South Korea, Brazil, and Indonesia. All have governments that consider it unwise to align too closely with the US, and they are preparing to shift their international orientation accordingly.
The implications will be clearest, and most costly, in four different areas. First, US corporations will face a more challenging landscape. This includes US telecommunications firms, banks, and credit card companies doing business in France, Germany, and Brazil when the regulatory environment becomes more hostile for those sharing information (knowingly or unknowingly) with the NSA. Or US defense companies selling into countries such as Turkey and the Gulf states, which want to diversify defense purchases away from the US (and, for the more price sensitive, away from NATO).
Second, expect less effective US efforts at multilateralism, which will lead to the weakening of US-led “coalitions of the willing” both on the collaborative side (the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership) and the punitive (international support for new sanctions regimes). Third, confusion over US commitments will complicate choices for countries balancing political and economic interests between the US and China—particularly in Asia, where Chinese economic influence is expanding quickly. Some governments will align diplomatic and economic agendas more closely with Beijing. Fourth, expect a weakening of international standards as the US is no longer seen as a credible driver of a single global market. This new globalization will include faster fragmentation of the internet, greater disunity in financial regulation and oversight, the weakening of NATO, and the formation of more unilateral and bilateral security arrangements.
2. Voters in six of the largest emerging markets—Brazil, Colombia, India, Indonesia, South Africa, and Turkey— will go to the polls in 2014 to choose lawmakers and president. Political, social, and economic dynamics in each of the seven countries differ widely, but elections raise the risk of pre-vote populist policymaking in all of them. As emerging market growth slows, many of these countries need a fresh wave of economic reforms to enhance productivity, avoid the “middle income trap,” and generate higher potential GDP growth.
3. China is making changes, and so there’s much more uncertainty within China—and more potential for both upside and downside.
Reforms might prove to be very successful, improving China’s investment climate and opportunities for integration into the world economy. Still, the government is loosening its hold on key reins of the domestic economy on an historic scale, and that could have serious unforeseen consequences.
4. Driven by the interaction of the continued progress of Iran’s nuclear program, the impact of sanctions that took more than half of the country’s oil exports off the market, and the dramatic electoral victory of President Hassan Rouhani last June, the possibility of a comprehensive negotiated settlement between Iran and the West has become real for the first time.
We believe that the P5+1 (the five permanent members of the UN Security Council plus Germany) and Iran will probably reach a final deal (60% chance). Iran’s economy is in dire straits, and November’s interim agreement offered scant sanctions relief. Tehran is incentivized to remain flexible and agree to an end-state deal that would provide a real economic boost. The probability of a deal creates significant risks in itself, especially given sharper tensions between Iran and Saudi Arabia, the expanding proxy war in Iraq, and the negative impact of a steep decline in oil prices on petrostates (more on that with risk #5). But that other 40% is still a very big number, and it’s worth looking at what happens if diplomacy fails.
5. If an agreement with Iran is reached, the gradual restoration of Iran’s export volume would almost certainly cause a selloff in an already increasingly bearish market.
That translates into petrostates around the world facing serious budgetary squeezes at a time when many are already in difficult economic shape, with mismanaged economies stemming from a legacy of easy energy money and no perceived need to build improved governance/diversify economies. Venezuela and Russia are likely to experience the most acute troubles, given a combination of institutional weak- ness and sinking popularity of their leaderships. Saudi Arabia, for its part, would have to take substantial volumes of its exports off the market to create a price floor.
In 2014, big-picture economics are stable if not yet comforting. The EU has clawed its way out of recession. Japan has, improbably, discovered economic leadership. The economic performance of China’s new government is strong. And the US re- bound is sufficiently robust for the markets to shrug off New Year’s tapering resolutions.
But geopolitics is very much in play. The realities of a G-Zero order, a world of geo- political creative destruction without global leadership, are evident. There are tensions between China and Japan in the East China Sea, elite-level executions in North Korea, Russia flexing its muscles in neighboring Ukraine and beyond, and everyone fighting with everyone else in the Middle East (some things don’t change). All of which is changing the geopolitical map quite aside from the role of the world’s only superpower.
1 America's troubled alliances
2 Diverging markets
3 The new China
4 Iran
5 Petrostates
6 Strategic data
7 Al Qaeda 2.0
8 The Middle East's expanding unrest
9 The capricious Kremlin
10 Turkey
1. The US is not in economic decline. Despite Washington’s many challenges, investors continue to bet heavily on the US economy.
In fact, the country’s economic growth story is one of the most exciting in the world, driven by energy and food production revolutions; game-changing technologies in diverse sectors such as manufacturing, wearable computing, genomics, nanotech, and advanced military hardware (with plenty of crossovers among them); favorable demographics; and strong underlying political and social stability. A diminished middle class, poor public secondary education, and a badly functioning new healthcare system are embarrassing political leaders but will do little to undermine corporate investment and international support for the dollar.
There is, however, a notable decline in US foreign policy. Some of this is structural—too many increasingly influential countries with which to coordinate effectively; a distracted Europe led by Germany (with geo-economic and bilateral sensibilities) rather than a more geopolitically aligned UK and France; and emerging markets, particularly Russia and China, more willing to challenge US preferences abroad.
US’s second-tier allies (who increasingly feel like second-tier allies). That’s a much larger group, including Germany, France, Turkey, Saudi Arabia, the United Arab Emirates, South Korea, Brazil, and Indonesia. All have governments that consider it unwise to align too closely with the US, and they are preparing to shift their international orientation accordingly.
The implications will be clearest, and most costly, in four different areas. First, US corporations will face a more challenging landscape. This includes US telecommunications firms, banks, and credit card companies doing business in France, Germany, and Brazil when the regulatory environment becomes more hostile for those sharing information (knowingly or unknowingly) with the NSA. Or US defense companies selling into countries such as Turkey and the Gulf states, which want to diversify defense purchases away from the US (and, for the more price sensitive, away from NATO).
Second, expect less effective US efforts at multilateralism, which will lead to the weakening of US-led “coalitions of the willing” both on the collaborative side (the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership) and the punitive (international support for new sanctions regimes). Third, confusion over US commitments will complicate choices for countries balancing political and economic interests between the US and China—particularly in Asia, where Chinese economic influence is expanding quickly. Some governments will align diplomatic and economic agendas more closely with Beijing. Fourth, expect a weakening of international standards as the US is no longer seen as a credible driver of a single global market. This new globalization will include faster fragmentation of the internet, greater disunity in financial regulation and oversight, the weakening of NATO, and the formation of more unilateral and bilateral security arrangements.
2. Voters in six of the largest emerging markets—Brazil, Colombia, India, Indonesia, South Africa, and Turkey— will go to the polls in 2014 to choose lawmakers and president. Political, social, and economic dynamics in each of the seven countries differ widely, but elections raise the risk of pre-vote populist policymaking in all of them. As emerging market growth slows, many of these countries need a fresh wave of economic reforms to enhance productivity, avoid the “middle income trap,” and generate higher potential GDP growth.
3. China is making changes, and so there’s much more uncertainty within China—and more potential for both upside and downside.
Reforms might prove to be very successful, improving China’s investment climate and opportunities for integration into the world economy. Still, the government is loosening its hold on key reins of the domestic economy on an historic scale, and that could have serious unforeseen consequences.
4. Driven by the interaction of the continued progress of Iran’s nuclear program, the impact of sanctions that took more than half of the country’s oil exports off the market, and the dramatic electoral victory of President Hassan Rouhani last June, the possibility of a comprehensive negotiated settlement between Iran and the West has become real for the first time.
We believe that the P5+1 (the five permanent members of the UN Security Council plus Germany) and Iran will probably reach a final deal (60% chance). Iran’s economy is in dire straits, and November’s interim agreement offered scant sanctions relief. Tehran is incentivized to remain flexible and agree to an end-state deal that would provide a real economic boost. The probability of a deal creates significant risks in itself, especially given sharper tensions between Iran and Saudi Arabia, the expanding proxy war in Iraq, and the negative impact of a steep decline in oil prices on petrostates (more on that with risk #5). But that other 40% is still a very big number, and it’s worth looking at what happens if diplomacy fails.
5. If an agreement with Iran is reached, the gradual restoration of Iran’s export volume would almost certainly cause a selloff in an already increasingly bearish market.
That translates into petrostates around the world facing serious budgetary squeezes at a time when many are already in difficult economic shape, with mismanaged economies stemming from a legacy of easy energy money and no perceived need to build improved governance/diversify economies. Venezuela and Russia are likely to experience the most acute troubles, given a combination of institutional weak- ness and sinking popularity of their leaderships. Saudi Arabia, for its part, would have to take substantial volumes of its exports off the market to create a price floor.
