“We now have a whole generation that does not remember the last time that geopolitics was a driver to price movements in markets,” said Philippa Malmgren, president and founder of DRPM Group, at the 2015 CFA Institute Middle East Investment Conference in Kuwait City. The geopolitics of the Middle East, the United States, Russia, and China has created a new Cold War of unquantifiable forces that is more than capable of moving markets, Malmgren told her audience of Middle Eastern investors.
What is making matters worse for investors is that “we are all so specialized these days,” Malmgren added. “We have a globalized, interconnected world that is being run by people in narrow and specific silos.” Malmgren’s mission is to return geopolitics to the forefront of the landscape where it belongs, having spent many years after the end of the Cold War on the sidelines of investor attention. She believes defense and geopolitics have been marginalized for too long, as investors bask in a post–Cold War peace dividend and long periods of moderate inflation.
In the last decade, we have created an extraordinary debt problem and a slowdown in the world economy that has been brought about by that debt, according to Malmgren. Central banks in the developed countries have been doing their level best to create inflation whilst at the same time saying their loose monetary policies are not yet having the desired effect and so must be continued, she added. For emerging markets, such as those in the Middle East, “it is hard to believe the addition of record sums of capital into the markets have had no effect,” said Malmgren. When quantitative easing was in full flow, commodities prices, property, rents, and stock markets all hit new highs.
The bottom line for emerging markets, according to Malmgren, is that the Fed is saying, “It’s our dollar, but it’s your problem.” This is especially so in the Middle East where so many currencies are tied to the US dollar through currency pegs — meaning the impact of US decisions is even greater. But for Malmgren, “this is not a purely economic policy issue; this is a geopolitical issue.”
The Great Game
Malmgren pointed to the long history of “the Great Game” in the Middle East, referring to the foreign engagement of powerful countries for control of commodity assets and the strategic value of physical location. She contends that the role of superpowers is now shifting and changing: China and Russia consider that the accumulated debt of the United States and other Western countries is so great it is politically unacceptable for it to ever be repaid, which means inflation and rising values for strategic assets. Other ways of dealing with excessive debt are off the table, she added, and full default of any kind by the United States and other developed countries is unlikely — even domestic austerity was too tough politically to make much impact on the debt.
The perception that actions by central banks in the monetary arena affect geopolitical events is a real one, argued Malmgren. For China and Russia versus the United States, this means they can say, “we don’t have to respond with monetary policy, we can respond with military policy,” said Malmgren, referring to a twist on Carl von Clausewitz’s comment that “war is the continuation of diplomacy by other means.” For China, this means securing commodities and assets required to keep its population stable, she added. The United States has “relatively” withdrawn from the Middle East, according to Malmgren, creating an entry point for China to become involved. Examples of geopolitics reasserting itself abound, such as the near misses of US spy planes and Chinese jets.
Malmgren said that Russia believes the world economy is not delivering the stability promised and finds itself in an environment of rising prices, which creates significant challenges. She cited when Ukraine, the fourth-largest food supplier in the world, sought to move away from Russian influence and join the EU. Malmgren added that Russia tends to look at the world as a trader might and ask what the value of any part of the world is — hence, its increased interest in commodity producing areas and ports or gas pipelines. She also stated that in the Middle East, commodities and physical access have assumed increased importance.
Increased supply of oil from fracking in the United States was supposed to decrease the importance of Middle Eastern partnerships and strategic value, but for Malmgren, this has not happened. “I always thought the market was discounting all the fracking much too far in advance,” she said. The United States is now engaging with Iran partly to offset entreaties of the Russians with Iran, so it seems stories of decline in Middle Eastern engagement with superpowers are overdone, she added.
Natural gas finds in the Mediterranean and Russian entreaties to draw Greece out of the European Union and into a new Eurasian Economic Union also suggest geopolitics continues to be alive and well, Malmgren asserted. Russia has even been getting involved with Egypt and is suggesting a permanent naval presence in the Mediterranean, she added. All of this, at least for Malmgren, is partly related to the US withdrawal from Iraq and Afghanistan, which leaves a superpower vacuum in the region. Malmgren sees yet more evidence of geopolitical manoeuvres in the actions of Chinese and Russian central banks buying up gold stocks. Whilst the geopolitical landscape is ever shifting, one thing seems certain to Malmgren — geopolitics is back and should no longer be sidelined.