Monday night’s foreign policy debate between President Barack Obama and his Republican challenger Governor Mitt Romney did little to dispel the notion that with less than two weeks to go until Election Day, we are headed for a neck-and-neck race with Romney gaining ground when it matters most.
No matter who wins on November 6, the next president will face a raft of geopolitical challenges over his four-year term.
Willis Sparks, an analyst in the global macro practice at Eurasia Group, a global political risk research and consulting firm, recently laid out some of the political fault lines that will shape politics and international finance in the coming years.
“Think about everything that has happened in the world in the last four years,” Sparks told delegates at the Asset Allocation for Private Clients conference. “We’ve had the largest financial crisis in this country and in the West generally since the 1930s, we’ve had the sharpest global slowdown since the end of World War Two, we’ve had an existential crisis ongoing in the eurozone, and we’ve had a wave of upheaval through the Arab world, across North Africa, and the Middle East. Any one of those four things would generate plenty of geopolitical ripples into the markets, but to have all four of them in the past four years, we’ve got something very unusual.”
Sparks said Eurasia Group believes the turmoil is likely to continue, making for a volatile era in international politics and global markets. He laid out four issues contributing to that volatility: the rise of China to become the world’s largest economy; energy issues; state capitalism, particularly in China; and the lack of global leadership.
The Rise of China
Sparks noted that depending on which bank report you read, somewhere in next five, six, or eight years China is going to have the world’s largest economy. “That will mean, for the first time since the industrial revolution, the largest economy in the world will belong to a developing country — a potentially unstable country,” he said. “A couple of years ago Premier Wen Jiabao of China said China’s economic development model was, in his words, ‘unstable, unbalanced, uncoordinated, and unsustainable.’ That is the economy on which the global economy will depend for a lot of its dynamism over the next 10 years, and that’s a source of volatility. And, in fact, we can say that over the next 10 years the global economy is going to depend on emerging markets generally, not just China.”
Sparks explained that since we are not expecting strong growth from Europe over the next couple of years, and we’re not expecting a surge of growth in the United States, at least not over the next couple of years (although Eurasia Group is “actually pretty optimistic over the US’s long-term future”), the key question becomes: Where will growth come from?
“It is going to come from emerging markets like China, India, Brazil, Turkey, Mexico, and South Korea, and some others. And the problem is that this injects politics, because in all of these countries, politics plays an outsize role in what happens in markets,” Sparks said. “We are talking about a global economy that is going to depend for much of its dynamism, maybe over the next generation, on some unstable and potentially unstable countries.”
He went on to say that after Goldman Sachs made the BRICs famous, they created the N-11, the Next 11, a group of countries that are going to power the global economy forward. These nations are the “next tier of emerging market countries and you will see some strong names on there, Turkey, South Korea, Nigeria, Pakistan, Egypt, and Iran, which is going through a pretty serious domestic economic crisis,” Sparks said. “A global economy that depends upon these kinds of economies for its dynamism is going to have politics play a larger role in what happens in markets, and it is going to be a lot less predictable and a lot more volatile.”
Sparks said that by 2020, the best estimates are that the United States is going to be getting 82% of its energy from “this side of the Atlantic Ocean,” meaning from domestic production, as well as from Canada, Mexico, Venezuela, and Brazil. While this may sound like good news for the United States, Sparks said it is “not necessarily good news for the global economy, because China, global economy number one, is importing more of its oil from the Middle East. China is already importing half of its oil and half of that comes from the Middle East, and by 2015 the estimate is that somewhere between 60%–70% of China’s energy is going to be imported. They can’t continue to rely on coal production. China is already home to 16 of the 20 most polluted cities on earth. They have to make an adjustment in their energy base, and they are going to become more dependent on oil from the Middle East and other potentially unstable parts of the world even as the US is becoming less dependent.”
The bottom line? “We are going to see more oil production in stable environments like Canada and Brazil, but we are also going see more coming out of the Middle East, out of West Africa, and the Caspian Sea basin.”
The state-capitalism model is one in which the government is the principal economic driver. The primary purpose of state capitalism is not to produce wealth but to ensure that wealth creation does not threaten the ruling elite’s political power. Sparks said state capitalism exists in many forms, and is practiced in small ways, even in democracies like Brazil. But it is really China’s state capitalism that is the cause for concern.
Sparks said that half of China’s GDP comes from state-owned companies. And by way of illustration, he mentioned two of the larger state-run companies, State Grid Corporation of China and CNPC, noting that State Grid has 1.6 million employees and CNPC has 1.2 million people on its payroll. “These are two state-owned companies, one in electricity generation and another one of China’s national oil companies, that together employ more people than the entire population of Mongolia.”
And why is something we should care about? “The best way to understand what state capitalism is is simply to say that no one understands better than the leaders of China and Russia that Communism doesn’t work. They lived it, they know it,” Sparks said. “The government can’t simply order up lasting long-term growth. They have lived with the consequences of the failure of that system. Markets must be allowed to work in China and Russia, but they also know that if they simply let markets work, if they simply let markets pick who the winners and losers are, they risk depriving themselves of the resources that they might need when things slow down and workers are displaced onto the streets, but they also risk empowering by enriching a group of people in these countries who might actually use that money to challenge the ruling party’s monopoly control of political power.”
Sparks said that in not-too-distant future we might find ourselves dealing with the weakness of state capitalism. In fact, he said, he would argue that China’s leaders are already beginning to deal with that now because they have already indicated that they believe some corporations have grown too large and need to be broken up.
“The large state-run companies have built enormous political influence within the system over the years. They have the means to fight back, they have the money, the political influence. A lot of these state-owned oil company leaders actually have positions in government within the Chinese leadership,” Sparks added. “While that may sound bad for China, it’s bad for everybody else, because we are going to be dependent on China for some of the dynamism in the global economy.”
Sparks said there is a lot less global leadership in the world today. “For the foreseeable future, America will continue to be far and away the most powerful country on the earth. That’s not going to change, but the US’s willingness to play the global leader has been reduced simply by the state of the US economy, long-term debt issues, et cetera. Leaders are important around the world because leaders write the checks that others can’t afford. Leaders force compromise on countries that don’t want it.”
He said that we used to live in a G7 world, but now the G20 is the model for global leadership. There are two problems with the G20, he said. First, it is a lot harder to get 20 people or organizations to agree on anything, than it is to get seven or eight. The second, and more complex problem, however, is that there is “a very broad divergence of opinion around that table about democracy, freedom of speech, human rights, free-market capitalism, the proper role of government in the economy, the rule of law, and a lot of other issues.”
Sparks believes that it isn’t actually a G20 world but rather a G-Zero world. “It’s a world where you don’t have the same global leadership that you had during the years when America could afford to play that [leadership] role with the help of Europe,” he said. “That means you are going to see more small problems, because large problems, and more large problems, become crises, and only when they become crises are people going to deal with them and that’s the hot spot issue in the economy.”
For more CFA Institute resources related to the US presidential election, see:
- Does the US Presidential Election Impact the Stock Market?
- Elections and Stock Prices: Assessing the Impact Is an Exercise in Futility
- Can You Time the Markets Based on the Presidential Cycle?
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