New world disorder: Why politics is the greatest single risk in global markets

Provided by PSS.
At Russell Investments’ recent Summit in Auckland, geopolitical expert, Dr. Alan Dupont shared his views on the likely results of the current power struggles between the United States, China and Russia, and the implications for investors.

Investors often question whether geopolitics needs to be on their radar. Yet in Dr. Dupont’s 40 years of observing risk, he has never seen a period of more geopolitical uncertainty than in the last 18 months.

Geopolitical shocks are shaking the very foundations of the established international order: the United Kingdom’s surprise Brexit decision, the equally unanticipated election of Donald Trump as the 45th President of the United States (US), and the widespread rejection of ‘politics as usual’ in the democratic West. These and other disruptive events are ushering in a period of great change that he calls the “new world disorder”.

It seems that now, more than ever, investors must consider this new geopolitical landscape because it has enormous consequences for market stability and investment decision making.

Dr. Dupont raises several questions for investors to consider:

1. Are these disruptive trends fleeting, or do they presage a long-term, cyclical shift in geopolitical and economic power?

To answer this question, Dr. Dupont argues we need to take a step back and see our current situation in its historical context. In the 1960s, political theorist George Modelski asserted that geopolitical super cycles occur every 100-120 years. At end of each super cycle, the dominant state starts to weaken, confronts challengers, its basis fragments and, often, the world is plunged into wars and conflict. We can see these cycles in play over the last 500 years. Every century or thereabouts, global leaders have been threatened by emerging challengers, with the resulting conflict eventually coalescing into a new, more stable global system, often under different leadership.

Until recently, our post-1945 world system was founded on Pax Americana and underpinned by the US military. In 1990, President George Herbert Bush talked of “…a new world order where the rule of law, not the rule of the jungle, governs the conduct of nations.” 

Dr. Dupont believes the world order President Bush was describing is unravelling. Western values are being contested by new players: rising, or resurgent, states; and non-state actors, including transnational criminals. We can see evidence of this right across the political spectrum: at one end, in the rise of identity politics, populism and nativism in the developed world; and at the other, in Islamic State’s ambition to destroy the old order completely and begin anew with a global caliphate.

If, as it appears, we are currently in the midst of a transition between super cycles, then we can expect major macro system change for at least a decade to come. In the new world disorder, the rules we have taken for granted throughout our lives – the capitalist system, free markets and the rule of law – may no longer hold.

Dr. Dupont believes this transition period is likely to be long lasting (10-30 years) and characterised by conflict, disruption and elevated levels of geopolitical volatility. Investors can expect to see the rate of geopolitical change accelerate, increasing the likelihood of breakdowns in the macro system until a new world order emerges. What we have been experiencing for the last 18 months is the new paradigm.
2. What will the new world order look like when the system finally stabilises?

With so many factors in flux, this is a thorny question. What Dr. Dupont states with certainty is that the world will not go back to the way it was.  There may be some elements of continuity, but not many.

To get a glimpse of a possible future, it is illustrative to look at potential challengers for world power and their likelihood of success.
  • Assertive China
China has much invested in the old system. However, President Xi Jinping is happy to change the rules that don’t suit him. Witness the South China Sea in which China is seeking to wrest control of the Malacca Strait from the US Seventh Fleet by aggressively militarising a number of reefs in the Spratly Islands. This integrated play for trade and energy security could easily become an arena for escalating conflict, with major implications for financial markets, unless Xi is able to position the development in a sufficiently diplomatic light.
  • Disruptive America
Pax Americana is dead and is being buried by President Trump.  But Trump is not responsible for its demise. His skill has been to identify and ride the crashing wave of systemic discontent surging across the US. What differentiates this presidency from previous administrations, is that, rather than being invested in protecting the old order, Trump is collaborating in pulling it down.
The US will survive Trump – it will eventually endure and strengthen because of its resilience and underlying strengths. But its reign of world dominance is over.
  • Aggressive Russia
Russian President Vladimir Putin’s revanchism has been clear for some time. Putin has taken every opportunity to shake up the old order, shocking Europe with his annexation of Crimea and destabilisation of Ukraine. Resentful of US unilateralism and Europe’s attempt to enlarge NATO, Putin will continue to assert himself on the world stage. He will use Trump’s NATO attacks to try to reset Russia-US relations. His marriage of convenience with China may fall apart over competition for power and influence in Central Asia where Russia has long held sway.
  • Weakened Europe
With Brexit, the European Union (EU) has not fragmented, but anti-EU sentiment remains in many countries. The question is how quickly this massive trading bloc will recover. With internal challenges far greater than those confronting the US, the likelihood is that Europe’s decline will be more difficult to reverse.

Implications for investors

China will not rule the world, but neither will the US nor Russia. We are going back to a more traditional multipolar system. In the current transitive state, disruptive transnational forces and emerging technologies will continue to accelerate geopolitical and economic change, causing greater uncertainty and volatility in the market. 

Given the complexity of the world’s economic and political system, making investment decisions in a silo won’t work. Smart investors will integrate geopolitical considerations into a holistic approach to risk management.  Good risk strategies won’t necessarily future proof an investment portfolio, but knowledge is always better than ignorance.

The Police Superannuation Scheme is managed and overseen by investment professionals who take geopolitical risks – and opportunities – into consideration when investing on your behalf. It’s also worth recognising that known risks, such as those outlined by Dr. Dupont, will already be reflected in the price of securities in your portfolio.  The value of your portfolio, rather, will be influenced by unexpected events, and such events are, naturally, difficult to foresee.

Source: Russell Investments

Dr. Alan Dupont
Dr. Alan Dupont is founder and CEO of the Cognoscenti Group, a political and strategic risk consultancy, and is one of Australia’s best known strategists, Asianists and thought leaders. Alan has an international reputation for his work on geopolitical risk, defence and national security and has been an advisor to a number of Australian ministers of defence and foreign affairs. In 2013/14, Alan established and led the Abbott Government’s Defence White Paper team. He has received commendations for his work from the governments of Japan and East Timor and was recently named by the Australian Financial Review as one of Australia’s top two strategists.

Alan holds a PhD in international relations from the Australian National University and is a graduate of the Royal Military College Duntroon and the US Foreign Service Institute. He is currently an Adjunct Professor at the University of NSW in Sydney, and a non-resident Senior Fellow at the Atlantic Council in Washington and the Lowy Institute for International Policy.

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