Geo-Politics Knocks the Markets
When we take a long-term view we are always conscious of the need to be aware of cyclical developments. Short-run economic cycles are superimposed upon long-run structural trends, sometimes coming powerfully together at times to drive markets.
In recent months, the economic cycle in western economies has been constructive for financial assets: growth has been relatively solid and inflation low. Then on top of this there are national factors, whether it be Fed tightening in the US, a slower pace of growth as inflation squeezes spending power in the UK before peaking this autumn, or politics across key economies in western Europe.
What then of geopolitics? I ask this as markets are knocked by the latest war of words over North Korea. I used to visit South Korea regularly and while I have not been to the North - or the Democratic People's Republic of Korea - I did spend a few hours in the DMZ - or Demilitarised Zone, back in late 2011. Also, to put things in perspective, I oversaw two separate pieces of work on what would happen if the North fell, Korea was united and the impact regionally and globally. I mention those pieces as - at various times over the last twenty years - tensions have risen in the Korean Peninsula and on occasions the wider politics suggested they might get out of hand or trigger significant change. Even more so than now. So investors need to know that this is not new.
At the beginning of last year, it was widely felt that North Korea would be the biggest immediate challenge for a new President Clinton. How things change - we now have President Trump and the Middle East and Russia have provided more worries over the intervening 18 months, but the problem of North Korea testing inter ballistic and other missiles just won't go away. Of course, the style and rhetoric of Trump is very different and the worry some have is that rather than defusing, it may inflame the situation, a valid concern.
Given the location, a mature relationship with China over this issue is also vital, not just in terms of helping resolve this issue but also to allow markets not to over react.
In investment, we think of these as small probability, high impact events. The chance of something happening is low, but if it does, it is widely seen as being important enough to impact markets and wider thinking. Trouble is you cannot predict with precision if something will go wrong and if you were to invest solely because of this you would miss all the other factors driving markets.
That being said, we take seriously all such issues and see whether there are quantifiable risks that we need to take into account. The risk, for instance, attached to a problem in Korea has increased. Having been heavily involved in country risk analysis as well as capital markets teams it is impossible to be precise, so we have to quantify the risks and take on board different scenarios or implications.
North Korea is a small, poor economy, with a population around 25 million. It may be developing a military arsenal but will have little strength in depth. It could cause trouble but not for long. South Korea, with 52 million people, is the twelfth biggest economy in the world. Seoul is only 30 odd miles south of the DMZ, the world's most fortified border.
When I visited the DMZ soldiers stood heavily armed on both sides of the divide, usually looking bored, look-out towers oversee the other side and just on the north side, almost in the middle, is "Prosperity Village", a showcase village of the North, almost toy town in its look. I also heard the tannoys in full force, no doubt conveying some propaganda. There in the DMZ you can also see the remnants of the tree, whose chopping down led Bill Clinton when President to put the whole allied army there on the highest level of alert, short of war. Yes, we have been there before. Which perhaps explains why in Seoul they usually tend to remain calm in the face of repeated threats from the North.
The reality is the whole region has lived with this issue for years and it has not held back growth, nor soured the geopolitics between China and the US and others. Last weekend the UN, acting in unison, tightened sanctions considerably against the North. And one hopes this, plus diplomacy, wins through.
The Six Nation talks to keep the peace have tended to proceed well over the years, but recently it has been left more to China to keep the North in check. The general feeling has always been that China favours the status quo, rather than seeing change which could initially be disruptive and which then might ultimately see a united Korea aligned with the US. In purely economic terms, north east China with the dynamic port of Dalian and cities likes Shenyang, while already doing well now, would likely prosper much more if the geopolitics of North Korea changed.
The biggest worry for the markets is the likely relationship between China and the US. This week markets were worried how China would react if the US acted unilaterally.
If this did lead to a military escalation with the North how might it play out? Given recent events, it would be wrong to downplay the risk of this getting out of hand. But at the same time, recent history suggests it is not inevitable it leads to war. And if it did, it is not inevitable that it becomes nuclear. But even if it didn't, would North Korean troops flood across the border, triggering military action with the south, and even if this was short-lived what might be the disruption as well as loss of life that it triggers. Equally, if it is not resolved now, another fear is that it triggers a further military build-up in north east Asia, also involving South Korea and Japan.
There have always been different views as to how this will play out. This is, in many respects, the last remnants of the Bamboo Curtain across Asia, but just as when the Iron Curtain fell in Europe in 1989, few saw it happening the way it did beforehand but after it had occurred no-one was surprised by what had happened.
Whatever happens, this north east Asia region could become more important. The biggest geopolitical challenge might well be seen here - in terms of the south and east China seas and various territorial disputes. Meanwhile, north east Asia is one part of a dynamic region across the Indo Pacific, which could help to drive future global growth.
From a longer-term perspective, savers and investors are best served by taking a long-view and seeing through such risks. Of course, what is happening now is that this latest phase of the Korean issue is occurring against the background of markets that have already discounted much good economic news.
We remain constructive about global growth. We also are keeping a close eye on the annual meeting of central bankers at Jackson Hole in Wyoming towards the end of August. Let's see if it is Draghi and Jackson Hole, not Trump and Pyongyang that markets are focusing on in a month's time.
In recent months, the economic cycle in western economies has been constructive for financial assets: growth has been relatively solid and inflation low. Then on top of this there are national factors, whether it be Fed tightening in the US, a slower pace of growth as inflation squeezes spending power in the UK before peaking this autumn, or politics across key economies in western Europe.
What then of geopolitics? I ask this as markets are knocked by the latest war of words over North Korea. I used to visit South Korea regularly and while I have not been to the North - or the Democratic People's Republic of Korea - I did spend a few hours in the DMZ - or Demilitarised Zone, back in late 2011. Also, to put things in perspective, I oversaw two separate pieces of work on what would happen if the North fell, Korea was united and the impact regionally and globally. I mention those pieces as - at various times over the last twenty years - tensions have risen in the Korean Peninsula and on occasions the wider politics suggested they might get out of hand or trigger significant change. Even more so than now. So investors need to know that this is not new.
At the beginning of last year, it was widely felt that North Korea would be the biggest immediate challenge for a new President Clinton. How things change - we now have President Trump and the Middle East and Russia have provided more worries over the intervening 18 months, but the problem of North Korea testing inter ballistic and other missiles just won't go away. Of course, the style and rhetoric of Trump is very different and the worry some have is that rather than defusing, it may inflame the situation, a valid concern.
Given the location, a mature relationship with China over this issue is also vital, not just in terms of helping resolve this issue but also to allow markets not to over react.
In investment, we think of these as small probability, high impact events. The chance of something happening is low, but if it does, it is widely seen as being important enough to impact markets and wider thinking. Trouble is you cannot predict with precision if something will go wrong and if you were to invest solely because of this you would miss all the other factors driving markets.
That being said, we take seriously all such issues and see whether there are quantifiable risks that we need to take into account. The risk, for instance, attached to a problem in Korea has increased. Having been heavily involved in country risk analysis as well as capital markets teams it is impossible to be precise, so we have to quantify the risks and take on board different scenarios or implications.
North Korea is a small, poor economy, with a population around 25 million. It may be developing a military arsenal but will have little strength in depth. It could cause trouble but not for long. South Korea, with 52 million people, is the twelfth biggest economy in the world. Seoul is only 30 odd miles south of the DMZ, the world's most fortified border.
When I visited the DMZ soldiers stood heavily armed on both sides of the divide, usually looking bored, look-out towers oversee the other side and just on the north side, almost in the middle, is "Prosperity Village", a showcase village of the North, almost toy town in its look. I also heard the tannoys in full force, no doubt conveying some propaganda. There in the DMZ you can also see the remnants of the tree, whose chopping down led Bill Clinton when President to put the whole allied army there on the highest level of alert, short of war. Yes, we have been there before. Which perhaps explains why in Seoul they usually tend to remain calm in the face of repeated threats from the North.
The reality is the whole region has lived with this issue for years and it has not held back growth, nor soured the geopolitics between China and the US and others. Last weekend the UN, acting in unison, tightened sanctions considerably against the North. And one hopes this, plus diplomacy, wins through.
The Six Nation talks to keep the peace have tended to proceed well over the years, but recently it has been left more to China to keep the North in check. The general feeling has always been that China favours the status quo, rather than seeing change which could initially be disruptive and which then might ultimately see a united Korea aligned with the US. In purely economic terms, north east China with the dynamic port of Dalian and cities likes Shenyang, while already doing well now, would likely prosper much more if the geopolitics of North Korea changed.
The biggest worry for the markets is the likely relationship between China and the US. This week markets were worried how China would react if the US acted unilaterally.
If this did lead to a military escalation with the North how might it play out? Given recent events, it would be wrong to downplay the risk of this getting out of hand. But at the same time, recent history suggests it is not inevitable it leads to war. And if it did, it is not inevitable that it becomes nuclear. But even if it didn't, would North Korean troops flood across the border, triggering military action with the south, and even if this was short-lived what might be the disruption as well as loss of life that it triggers. Equally, if it is not resolved now, another fear is that it triggers a further military build-up in north east Asia, also involving South Korea and Japan.
There have always been different views as to how this will play out. This is, in many respects, the last remnants of the Bamboo Curtain across Asia, but just as when the Iron Curtain fell in Europe in 1989, few saw it happening the way it did beforehand but after it had occurred no-one was surprised by what had happened.
Whatever happens, this north east Asia region could become more important. The biggest geopolitical challenge might well be seen here - in terms of the south and east China seas and various territorial disputes. Meanwhile, north east Asia is one part of a dynamic region across the Indo Pacific, which could help to drive future global growth.
From a longer-term perspective, savers and investors are best served by taking a long-view and seeing through such risks. Of course, what is happening now is that this latest phase of the Korean issue is occurring against the background of markets that have already discounted much good economic news.
We remain constructive about global growth. We also are keeping a close eye on the annual meeting of central bankers at Jackson Hole in Wyoming towards the end of August. Let's see if it is Draghi and Jackson Hole, not Trump and Pyongyang that markets are focusing on in a month's time.
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