No More Geopolitical Risks Please: Kemp

Editor’s note:  John Kemp is a Reuters market analyst. The views expressed are his own.

By John Kemp

LONDON, Dec 4 (Reuters) – “Warning lights are flashing over the global economy,” Britain’s finance minister, George Osborne, told a packed House of Commons on Wednesday during the last major economic debate of the current parliament.

Osborne was getting his excuses in early as parliament prepares for a general election in May 2015. “Japan is in recession, the euro zone is stagnating, and the geopolitical risks are rising,” according to Osborne, who warned that forecasts for Britain’s growth had been downgraded as a result (“Autumn Statement” Dec 3, 2014).

The first two threats are self-explanatory, but the “geopolitical risks” to Britain’s recovery are mysterious. I have spent most of my working career on international economic and political issues, and I have no idea what Osborne actually meant by this phrase.

The biggest threat to Britain’s economy at present is without doubt the slowdown in the euro zone economy, which is its largest trading partner. But it is not clear whether Osborne included political and economic problems in the European Union in his idea of geopolitical risk or not (the text implies a distinction between economic problems in Japan and the EU on the one hand and political risks in the rest of the world on the other).

Geopolitical risk has become a convenient catch-all to describe problems overseas. It can encompass everything from wars, insurrections and sanctions to recessions, debt defaults, expropriations, financial crises, epidemics and more.

The term is so broad as to be meaningless. Each of these events poses a specific and different type of threat to national security and economic well-being. Lumping them together actually makes the risks harder to analyze and understand.

It also encourages policymakers, analysts and journalists to blame problems at home on a rise or fall in the general level of geopolitical risk, like a thermometer, through a mechanism which is never explained.

Policymakers like to talk about geopolitical risk in the same way central bankers invoke “uncertainty” to explain economic underperformance and why they are unsure about their forecasts.
In this lexicon, geopolitical risks are almost always “elevated” in the same way that the economic and financial outlook is more often than not “unusually uncertain.”

As a simple matter of arithmetic, geopolitical risks cannot be elevated most of the time, any more than the outlook can usually be unusually uncertain.

NORMAL STATE OF AFFAIRS

Geopolitical risk and uncertainty are part of the normal condition of affairs. There is no reason to believe that the current level of risk and uncertainty is any higher than in past decades.

U.S. Presidents Reagan, both Bushes, Carter, Nixon, Johnson, Kennedy, Eisenhower and Truman would fiercely dispute the idea that current geopolitical risks are higher than the challenges they had to face in the 1980s, 1970s, 1960s and 1950s.

To take just a few examples of the problems they had to deal with: 9/11; SARS; two wars between the United States and Iraq; the Asian financial crisis; the Iran-Iraq war; the Iranian revolution and hostage crisis; Latin America’s debt default; the Soviet invasions of Afghanistan, Czechoslovakia and Hungary; the Arab oil embargo; the Cuban missile crisis; the Berlin airlift; and full-scale wars in Vietnam and Korea.

Turbulence and crisis, not peace and stability, are the norm in the global system. To blame economic and financial problems at home on “geopolitical risk” is to say the economy is not growing faster because history is unfolding in the rest of the world.

There is no obvious connection between geopolitical risks, economic growth and asset values. The supposed golden era of U.S. economic growth in the 1950s and 1960s coincided with major wars in Korea and Vietnam and a confrontation with the Soviet Union, which culminated in the Cuban missile crisis.

Researchers have not found a clear empirical link between world politics and the performance of the U.S. stock market. Even major events, such as the Cuban missile crisis, have had little or no impact on market valuations. Major stock market crashes have often occurred in periods of relative international calm.

There is no question international events can have a major impact on economic and financial performance at home. But unless the type of risk and the transmission mechanism is specified, it becomes impossible to make the connection properly.

In drafting his text, Osborne’s speech writer probably had in mind a range of current international problems from the outbreak of Ebola in West Africa and the conflict between Russia and Ukraine to the fighting in Iraq and Syria and the threat of terrorism.

But it is not clear which of these threats he thought affected Britain’s economy or how. Oil prices, often cited as a barometer of global political risk, have actually fallen 40 percent since late June. That drop should actually be a source of stimulus in the global economy and suggests the level of political threat is not especially high at the moment.

The bottom line is that “geopolitical risk” is not a useful or meaningful concept when speaking about international events and their consequences for the economy and financial markets.

This is one instance when greater precision is vital to analysis. It is more useful to talk about the specific and different challenges posed by war, sanctions, epidemics and financial crises.

It is time to retire the concept of “geopolitical risk” in favor of specifying those events that are thought to pose a threat, and how, to the economy and financial markets at home. (editing by Jane Baird)

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