Open a newspaper. Any newspaper. Read the front page and then the business pages. Absorb, assimilate, repeat. After half a dozen goes, you may notice a pattern.
This is a paper of two narratives. The front pages are beset by geopolitical worries, national disunity and social tensions. The business pages talk hopefully of growth, fret about the withdrawal or sufficiency of stimulus, and obsess about perennial concerns such as the property market.
There is a disconnect between the two. Islamic State, Ukraine, tensions in the South China Sea, separatist movements in Spain, Italy and elsewhere – all of these and their brethren are conspicuous by their absence of relevance to the financial markets. Indeed, one may go so far as to say markets and investors are remarkably sanguine in the face of what seems like a fraught global environment.
There is some movement. The Norwegian oil fund and APG recently said they were closely monitoring the situation in Ukraine and mulling divesting their Russian holdings. PFZW divested from five Israeli banks over their financing of settlements. The rapid spread of Ebola and the appearance of the first case in the US has caused some jitters in stock markets as October begins.
But these do not reflect an appreciation of geopolitical risk and other softer risks that are a priori harder to quantify. Rather, they are symptoms of the growing importance of ESG and political activism to investment decision making. The current mantra among investors is to view these tremors as transient dislocations and buying opportunities. The Ebola mini-panic owes more to weak manufacturing data and in the mean time related healthcare stocks have surged.
This is cognitive dissonance in action. It is the result of 60 years of general political and social stability, which has deluded markets into extrapolating these perceived patterns into the far future. Markets are deemed to sit in an ivory tower, unsullied by the murkier world beyond. But, ivory or not, the tower and the world share a common foundation.
You cannot divorce economics from people, politics, geography and society. The norm historically is that these have all been important influences on the course of money and economies. It is the last few decades that are the aberration.
The truth is, macro matters.
Not just interest rates, inflation, GDP and the other metrics that data-mongers are so fond of. Those are simply lagging indicators that reflect the evolution and impact of deeper trends in the world around us. It is these that determine the ebb and flow of risks and returns. Without an understanding, we tackle the world with one hand tied behind our backs.
Take geopolitics. The far-reaching influence of the US today is rooted in two facts: its military strength and the status of the dollar as the reserve currency of the world.
Today, 70 years on since it ascended to the podium, almost all global trade is conducted in dollars and foreign countries are amongst the largest holders of US Treasuries. This has cemented the hegemony of the US – a tactic presciently summarised by the US journalist Ludwell Denny in his 1930 book America Conquers Britain, which examines the passing of the baton from Britain to the US, “We shall not make Britain’s mistake. Too wise to try to govern the world, we shall merely own it”.
For the US, there are clear benefits to this dominance. Its global clout has been evident most recently in sanctions against Iran over its nuclear weapons programme and Russia over Ukraine. However, there are also unintended consequences to this. The impact of sanctions on Russia has been punishing precisely because Russia chose to open its markets and integrate more fully into the dollar-based infrastructure of global financial markets.
In short, it is paying the price for embracing globalisation. As this becomes a noose around its neck, Russia’s economic priorities are already shifting. The recent Russia-China bilateral energy agreement – worth some $400bn (€319bn) over 30 years – will use rouble and yuan in addition. This reduces the reliance of both on the US dollar and suits political ends.
But it is only one of a growing number that circumvent the dollar, as other countries – particularly in the emerging markets – seek to mitigate the spillover effects of Fed tapering on their economies and key political imperatives such as energy and food security. The BRICs have announced their own development bank, which notwithstanding window dressing, is a direct competitor to the World Bank and IMF.
These are emerging and worrying fissures in the global picture, with two significant consequences. First, they fuel a drive towards protectionism and autarky, as domestic concerns overwhelm globalisation. Ukraine is but one example of a growing number of geopolitical spats that are focused on resources, such as in the South China Sea, while elsewhere, muted growth has raised social discontent. The recent blocking of World Trade Organisation talks by India over food subsidy concerns is evidence in point.
Second, as countries focus on bilateral trade agreements, the danger is one of a ‘balkanisation’ of finance. Credit flows become regional in nature in response to demand. This is an inadvertent form of protectionism, as globalisation is financed by international credit flows. The effect is accentuated by the bailout of many financial institutions in the last financial crisis, which created a convergence between banks and sovereigns. This has also given birth to an ongoing clash between political and macroeconomic objectives, for example, pressure on banks to deleverage while also boosting lending to key political sensitivities such as housing or SMEs. Increasingly, therefore, banks are acquiring a domestic bias and retreating from peripheral to core territories. The result has been a steady fall in cross border claims and the erosion of key international links.
None of this is healthy for global trade and by implication for global growth. At the same time, it also creates opportunities elsewhere. The future of our portfolios have geopolitics writ large over them.
Macro matters. We ignore it at our peril.
Bob Swarup is the author of bestseller, Money Mania: Booms, Panics and Busts from Ancient Rome to the Great Meltdown (Bloomsbury, 2014) and a is Fellow at the Institute of Economic Affairs. His Macro Matters blog will be hosted on ipe.com
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