Geopolitical tensions

 In Articles

Europe reacted remarkably assertively to the Belarusian hijacking of a Ryanair flight from Greece to Lithuania. Onboard was journalist and opposition member Roman Protasevich, who is now facing the death penalty. European airports have been closed to flights from Belarus and airlines must now avoid Belarusian airspace. Naturally, Belarus was not operating without Kremlin authorisation, and it is possible that Putin did not expect such a harsh reaction. The European Union did nothing about the build-up of troops on Ukraine’s borders earlier this year. It also remained remarkably silent after evidence that Russians were behind the sabotage of a Czech arms depot in 2014. Moreover, the Belarusian action was similar to the European interception of Bolivian President Evo Morales’ plane. This was on its way from Russia to Bolivia and there was information that Edward Snowden was on board. The airspace of France and Portugal was closed, forcing the plane to land in Vienna, where it turned out that the whistleblower was not on board. Morales condemned the action, but did not go so far as to deny European airlines access to Bolivia. According to Ursula von der Leyen, however, this was really an attack on European sovereignty. One more step and Article Five of NATO will be activated. It will probably be more of an attack on European unity than on sovereignty. Any such sanctions must be approved unanimously. Last year, Cyprus blocked sanctions to force the Union to take a harder line on Turkey. Otherwise, there is always Victor Orban. He made sure that Europe could not condemn the developments in Hong Kong and also sabotaged the call for a ceasefire in the recent attack on Israel.  

The relationship between Russia and China has never been closer. Although both countries were communist, different national interests long created a red schism. Destalinisation in particular did not go down well with the Stalinist Mao Zedong. Earlier this week, Yang Yiechi, the most important Chinese diplomat, visited Putin. Yang was also the leader of the recent American-Chinese meeting in Alaska. The Chinese were not offered breakfast, lunch, or dinner there, it seemed for a moment that Trump was still firmly in the saddle. The normally so reticent Chinese reacted with harsh language, something that is now known as Wolf-Warrior diplomacy, after the title of a Chinese Rambo film of the same name. China is looking for a confrontation, the attack. This started under Trump, but now threatens to escalate under Biden. Meanwhile, the Persian Gulf is no longer the geopolitical centre of the world, but the Taiwan Strait. On 1 July, the 100th anniversary of the Chinese Communist Party will be celebrated, and Chinese people attach great importance to anniversaries, especially with such a round number. Both China and the United States are emphasising self-sufficiency combined with protectionism. Something that is doomed to fail, as Nehru and Gandhi can testify after the Indian experiment in the 1960s and 1970s. China and the United States are condemned to each other, but the geopolitical threat is a new reality.

Geopolitical risks occur when there is a threat to normal relations between countries or regions. Geopolitical events are important for financial markets, but their impact differs from country to country. Geopolitical risks are often extreme, but at the same time very binary. It is not a problem for a long time until it is. Suddenly, the people from Clingendael are on television to point out the problems. 

Academics and analysts have built barometers of geopolitical risk to help investors gauge the instability caused by geopolitical events. One of these is the Geopolitical Risk Index (GPR) by Caldara and Iacoviello. This index screens for news headlines related to geopolitical tensions, wars, or terrorism. According to the designers of this index, there is a positive correlation between geopolitical risks and capital flows from emerging markets to safe havens such as the US dollar and Japanese yen in times of stress, although monetary mismanagement increases the likelihood that the Chinese renminbi will be the next safe haven. The associated higher risks depress equity returns, drive up the VIX index and increase credit spreads.  

Yet the link between financial markets and geopolitical risks is not straightforward. This is because there are two types of geopolitical risk. The first typically creates an entry point, a buy-the-dip. Many geopolitical tensions end in a fizzle. Even the most insane dictator is amenable to reason under high pressure. No one has an interest in an extreme escalation. The second geopolitical risk is a change in fundamentals. A good example is the fall of the Wall that marked the end of the Cold War. In the years that followed, financial markets cashed in on the peace dividend. This interwar period lasted until the next geopolitical event with fundamental impact, namely the attacks of 11 September 2001. According to the analysis of Caldera and Iacoviello, markets suffer more from geopolitical threats than from actual events, such as the outbreak of war or the imposition of sanctions. The threat creates large and long-lasting effects that translate into a higher risk premium. However, it is often a case of possession, end of enjoyment. As soon as the threat materialises, the fun stops. Usually, the stock market rises again a month later.

Recent Posts
Contact Us

We're not around right now. But you can send us an email and we'll get back to you, asap.

Receive our FREE Strategy Reports 

Select from Alpha, Alternative, Overlay and Compounding; or get them all. 
GET STRATEGY REPORTS
close-link