Political risk has become more complex with the traditional divide between left and right being replaced with a conflict between globalisation and nationalism, writes Bob Swarup
The world is a complex place but the average human brain only weighs 1.4kg. We live in a dynamic, increasingly interconnected world that paradoxically bombards us with information to absorb and yet demands quicker decisions. The trick is to curate, distil, and reduce that complexity to something more manageable within our evolutionary constraints.
This column assesses a selection of macro risks relevant for pension funds at a high level; with a view to their evolution over 2017. We also delve into more detail on dynamics that bear further thought. These often cross multiple buckets, reflecting the interconnectedness of our world. Importantly, this is not an isolated exercise but, a regular updating to aid assessment and inform action.
Where are we heading in 2017?
Left, right, in, out?
Right wing (definition): As with the left wing, half the propulsive force of a flightless bird.
Richard Summerbell, Canadian author and biologist
The only thing worth globalising is dissent.
Arundhati Roy, Indian author and activist
An economy never exists in isolation. Rather, it has political and social dimensions by virtue of the fact that its actors are humans and its stage is society. Its development influences and is influenced in a constant feedback mechanism that gives us the economic cycles of growth and disruption we observe, most notably in recent times, the cycle of globalisation and deglobalisation discussed last quarter.
To ignore these facets as we navigate turbulent global times is akin to driving down the motorway gazing only at the satellite navigation and not ahead or around. There is movement and progress – for a while – but it soon comes to a sudden and unexpected jarring halt, because you ignored all those other people, traffic lights and hazards.
Nowhere has that been clearer than in the emerging populist response to the global financial crisis of 2007-09. Quantitative easing (QE) and monetary policy may have saved the system. However, the inability to understand the impact on people and society, the lack of accompanying structural or political reforms, and the unequal distribution of outcomes have combined to create a wave of global discontent and a move towards once-fringe parties.
To typify this as transient populist claptrap is to miss the point. This is a battle of conventional political ideologies of left and right, sharpened by economic disaffection. This is now a battle of outward versus inward, of autarky against openness, of globalisation against nationalism.
In this battle, we are no longer left or right, only in the world, or out of it.
For all of the recent political and geopolitical volatility, markets have shown little interest other than in the price of oil and the dollar-pound exchange rate. That is about to change.
In the coming year, politics will come to define economics and markets once again. In Europe, elections beckon and will test the dogma of the European project. And globally, countries – both emerging and developed – continue to seek answers in decisive leaders who promise certainty and authoritative ‘leadership’ in a volatile environment.
The political Mobius spectrum
As humans, we like shortcuts. They allow us to reduce a complex world to simpler buckets, and make decisions more quickly. Credit ratings are an example. The political spectrum is another.
For that, we have the French Revolution to thank. Although a short-lived experiment, it produced lasting legacies. One of the lesser known ones is that it gave the world the political notions of left wing and right wing.
The terms first appeared in its immediate aftermath to differentiate the members of the National Assembly from those who supported the revolution (and sat to the left of the president) and those who supported the king (and sat to the right). The term caught on. Future assemblies introduced moderates who gathered in the centre and further hair-split groups by introducing labels such as extreme left, radical left, extreme right, centre-left and centre-right to capture where they sat in the assembly and ideologically.
“The rise of populist parties was inevitable, as they proved sensitive to socio-economic concerns at a time when mainstream parties were not. That is the nature of representative democracy”
By the early 20th century, the labels had become shorthand for political leanings. The traditional view has these as a linear continuum with communism at the left extreme end giving way to socialists, democrats, republicans and finally fascists at the extreme right.
However, the distinctions are far more fluid and, like credit ratings, they fail to capture the evolution of the underlying actors. What worked for corporate bonds changed as financial institutions rose in prevalence, capital structures grew more complex, and as new structures began to slice and dice credit risk, as well as cashflows. The inability to realise and allow for this was a large part of why fingers were burnt in 2007.
Politics is the same and the underlying actors are always evolving. In the 19th century, republicans were a label attached to the left-wing. Today, they have migrated to the right. In today’s world, ideas, technology and capital travel freely, people less so. We remain bound by geography, social ties and our local environment.
The continuum is not linear as much as circular, with opposite ends twisting and converging to form a fluid uninterrupted surface, much like a Mobius ring.
In other words, the distinction between left and right becomes meaningless at some point. At their extremes, whether communism or fascism, both represent a desire for external authority and a dissatisfaction with the direction of society. Both prioritise the state above the individual, co-opting the latter towards allegedly better outcomes for society. Both argue for benign dictatorship and often a one-party system.
Outside of semantics and slogans, what is the difference?
A person may easily start off at the ‘centre’ and migrate around our Mobius ring, eventually towards once-extreme positions, as they respond to changing circumstances. Once outward facing, society rapidly turns inwards without its leaders realising.
Those of us who take globalisation for granted as an edifice of the investment landscape would be remember this.
Political parties respond to both voters and external markets. The two are often in tension. For example, Italy currently grapples with social dissent over a dysfunctional economy versus securing international support to bail out its fragile banking sector. While elections motivate parties to respond to public opinion, economic interdependence distracts them from their electorate and towards financial markets and external bodies.
In other words, globalisation makes political parties less sensitive to voters and more sensitive to investors. If we take one measure of globalisation as cross-border economic flows and the lack of restrictive measures, then research indicates that as a country’s measure of economic globalisation increases, political parties become less responsive to public opinion.
As this has iterated over the last quarter of a century, we have ended up with a benign environment for investors, where downturns are transient, growth will always return and policymakers support the economy and markets at all costs. But we also have a political centre and economic elite that are globalist, and a population that has migrated to become nationalist.
In this content, the rise of populism was inevitable, as they proved sensitive to socio-economic concerns at a time when mainstream parties were not. That is the nature of representative democracy.
Key macro risks
Financial market risks
•Impact: Medium to low
To say markets are expensive is to state the obvious. But for now, monetary policy continues to support it. Central bankers have retreated from their prominent outpourings, but continue to work monetary magic behind the scenes. Still, change is afoot. QE has lost its appeal as criticism of the impact on savers grows. Negative interest rates have added support but are eroding bank profits. Political uncertainty has stymied business planning. The financial infrastructure underpinning markets is eroding and becoming more fragile, which is a problem given our close relationship with derivatives and refinancings. The falls in cross-border lending and trade, coupled with currency jitters, will begin to ripple through markets and we expect an increase in profit warnings. The push for yield continues and private assets continue to see strong demand. However, there is a limited pool of opportunity out there and too few investors investigate the origination capabilities of their managers. It is probably fair to say that too many ALM investors are focused on hedging the measure, and too few on the real emerging problem of cashflow at risk.
Geopolitical and socio-political
•Impact: Medium to high
As populist concerns drive policy and the apocalypse fails to materialise, Brexit has moved from a reasoned debate to an ideological one. Hard or soft Brexit appears to be the new civil war that threatens the Conservative party, bringing renewed economic and business uncertainty. Interestingly, in the wake of UK government pledges to Nissan, many industries are preparing their wish-lists for any future ‘free trade’ agreement with Europe and support thereafter. That will only complicate negotiations in Europe and globally. In Europe, elections loom for France and Germany. The rise of the National Front and AfD (Alternative for Germany) have changed the rhetoric coming out of major parties already, while French President François Hollande commands a 4% approval rating. Meanwhile, Russia and the US are starting to embark on combative friction, as the US grapples with domestic dilemmas like the future of Obamacare. Allegations of voting fraud and hacking are reminiscent of 1980s paranoia, and countries like Syria are becoming geopolitical battlelines.
•Impact: Medium to high
US wages are rising, UK inflation is reappearing. Policymakers are starting to see shoots after nearly a decade of hoping. But this is not a benign inflation born of demand, that still appears to be lacking.
Rather, part is policy-led – such as the rise in minimum wages – and part is currency-led, that is, the collapse in sterling. Both put pressure on individuals and companies. The last few months in the UK have seen a stand-off between Unilever and Tesco as well as rising prices for domestic staples. This puts pressure on business margins and a greater drive for automation, creating a vicious circle as workers demand higher wages to compensate. Taking the US auto industry as an example, motor vehicles and parts production has increased 165% since June 2009, while employees have increased only 48% – a stunning rise in productivity and labour resentment.
The pressure is on the Federal Reserve to raise rates but any sense of monetary withdrawal threatens the many debt zombies and their strategy of extend and pretend, and, in Europe particularly, may create new taper tantrums. We expect a rise in wage bargaining in 2017, resulting in the beginning of a shift from higher returns to capital towards higher returns to labour.
Climate change will not disappear because other concerns dominate headlines. The US has endured a drought this year, which has driven down crop yields, with little attention or discussion. Meanwhile, the process for exploiting new mines and tapping new infrastructure has extended, as environmental and societal barriers grow higher. Commodities remain unloved but there are bottlenecks approaching for both food and metals as investment and financing dry up.
Migration remains a dominant narrative, coupled with labour worries, resulting in growing divisions. The rise of authoritarian populism, accentuates this negative environment for growth and trade. As feared, it looks like Brexit – hard or soft – will come to who wins the fight over ‘protecting’ Britain’s borders.
In the tech sector, Uber, Airbnb and other technological disrupters find themselves at a new series of flashpoints. Uber now has employees and commensurate benefits, with further lawsuits to follow. Airbnb faces a legal battle in New York and having to learn about lobbying and policy. Tech is growing up but it also faces growing costs and pressures to pay more in taxes.
Fintech – the current golden goose – is untouched for now but how long before regulation impedes and financial institutions start complaining about the unfairness of it all?
Now the pendulum is turning, as politicians wake up to this changed paradigm. The rise of UKIP and Brexit is but one example, where the Labour party saw its base erode in the north of England as immigration and economic concerns trumped whether voters were left-leaning or right. In response, Theresa May’s Conservative government has taken a harder tone on Brexit emphasising the primacy of domestic concerns and espoused nativism over multilateralism. Workers are important; capitalism needs to do more and pay more; foreigners are not welcome. In Europe, the ideological creed of free movement and the European project is under threat from its members, and the spectre of elections has focused politicians on their populace first. Parties such as the far-right Jobbik party in Hungary and the left-wing Syriza party in Greece are united more in their economic policies, autarkic mentality and opposition to perceived unaccountable elites than they are different.
“In this environment, many of our core assumptions as investors such as the primacy of free trade, the ease of credit, and the support of policy no longer necessarily hold true. We need to analyse, not demonise, or else we will fail to address and risk repeating the experience of the 1920s and 1930s. Much like then, this clash threatens to define both the coming decades of economic growth and over time, even the geographies of countries”
The two main candidates in the US presidential election both agreed that the American worker needs to be protected and capitalism needs to serve society. If they differ, it is only in instrument and process.
Today, the battle is between openness and autarky, between open societies and closed ones, between globalisation and nationalism. It is no longer a choice between left and right. The landscape is more complex. For example, countries in the developed world are trending towards autarky while cities remain global, both driven by their experiences, as with the UK and London for example.
In this environment, many core assumptions of investors such as the primacy of free trade, the ease of credit, and the support of policy no longer necessarily hold true. We need to analyse, not demonise, or else we will fail to address and risk repeating the experience of the 1920s and 1930s. Much like then, this clash threatens to define both the coming decades of economic growth and over time, even the geographies of countries.
Bob Swarup is principal at Camdor Global Advisors, a strategic investment and risk advisory firm. His email is email@example.com.
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