x Abu Dhabi, UAEFriday 28 July 2017

Reality check on globalisation leaves a new world of distrust

Lack of trust in politicians is at the core of the current market anxieties, in both the US and Europe.

There was a brief moment, in the go-go 1990s, when the world seemed less reliant on politics and politicians. Globalisation, we were told, was on the march. Markets - efficient and calculating and precise - would dictate our future, not politicians - venal, short-sighted and imprecise. As long as nations hopped on the chugging globalisation train, they, too, would benefit and the ride would be smooth.

Of course, the world may be flatter as result of globalisation, but history is not. It is bumpy and littered with surprises, challenges, obstacles - and corpses. And markets were never as efficient as their cheerleaders crowed. Today, as the United States flirts with a double dip recession, Italy and Spain stand on the verge of a debt precipice that could shatter the euro zone, China's growth engine slows, Egypt's future is fraught with uncertainty, and several Arab Spring states are caught in an unpredictable cycle of uprising and state violence, we face a unique confluence of geopolitical and geo-economic risk that might be described as "the new normal".

This "new geopolitical normal" offers a new twist to the "world is flat" narrative which, at the time, was framed in positive terms. After all, Indian outsourcers supporting the work of US corporations, building India's middle class and creating new efficiencies for US companies seemed to be a win-win. But the flattening world - or better yet, our hyper-connected world - also means that a debt crisis in a small euro-zone country like Greece or Portugal could threaten larger and healthier economies like France and Germany's. It also means that the suicide of a Tunisian vegetable vendor, Mohammed Bouazizi, could spark a fire that still sweeps across the Arab world today.

Navigating the new geopolitics of hyper-connected risk will require a steel spine, an understanding of underlying fundamentals, a stomach for volatility and a sense of market psychology. How else to survive a day like last Thursday? The US Dow Jones Industrial average - the bellwether index watched by traders across the globe - fell more than 4 per cent, its worst drop since the 2008 financial crisis. Oil prices fell to a three-month low. The euro tumbled against the dollar. Worries about sovereign debt in Italy spiked. Even that safest of save havens, gold, felt the pinch.

One day later, a positive jobs reports comes out in the United States, spurring a market recovery. Three days after US politicians pushed US debt to the brink in Congress, the world still saw US Treasury bonds as a safe haven. European leaders showed renewed commitment to erecting a wall around Italy and Spain and, for a moment, market uncertainty eased.

Then Standard & Poor's, the global ratings agency, downgraded the US sovereign credit rating for the first time, citing "political brinkmanship" that made America's ability to manage its finances "less stable, less effective and less predictable".

Standard & Poor's did not spell it out, but their credit downgrade was effectively a political downgrade, rather than an economic fundamentals downgrade. After all, there was never really any danger of America not meeting its obligations. US Treasury bonds are still highly sought after safe-haven debt instruments, thus allowing the US to finance it deficits and debt. Furthermore, the US faces neither a financial bubble nor a technology bubble and its corporations are flush with cash.

Standard & Poor's effectively said that its trust in America's politics to guide the country through its troubles has fallen a notch. This is a critical point because it reminds us that politics and policy are back (they never really went away, despite what the market enthusiasts of the 1990s said).

Thus, a key to navigating this new geopolitical "normal" will be the decisions made by policy-makers. As Jason Trenert, a New York-based market strategist put it in the Wall Street Journal: 'The bad news is that the market is largely dependent on the decisions of a small number of policy-makers rather than on fundamental concerns."

Take Italy, for example. While its debt load is indeed high at 120 per cent of GDP, it runs a budget surplus. Its biggest deficit, however, might be called "the Berlusconi deficit" - the lack of confidence that markets have in the Italian Prime Minister mired in scandal. It's essentially a trust deficit.

This political trust deficit in Italy and increasingly in Spain threatens the more robust economies such as Germany, France and the Netherlands. Even if the German Central Bank retains a strong trust brand, it may not be enough in a euro zone hyper-linked by a common currency - regardless of the underlying fundamentals of Germany or France.

As for the Middle East, the events of the Arab Spring have added a new layer of geopolitical risk in the minds of many investors - again, regardless of the market fundamentals in Qatar, the UAE or Saudi Arabia. All will have to contend with the market psychology ramifications of continued unrest in Syria, Libya, Yemen and Egypt. This is simply the new geopolitical reality.

The US political strategist James Carville once famously said that when he dies, he would like to be brought back to life as the bond market, "because then everyone would fear me." True, but in this new geopolitical normal, the bond market has grown to fear politicians too and that fear is mostly rooted in a lack of trust.

Of course, mistrusting politics and politicians is nothing new. It's just more consequential in moments of extreme economic turbulence.

 

Afshin Molavi is a senior fellow at the New America Foundation, a Washington think tank. Faisal Al Yafai is away and returns next week