ReutersGeopolitical risk looms large thanks to conflict in Ukraine and the Islamic State insurgency in Iraq and Syria, among other factors. File photo: Valentyn Ogirenko.
Davos - Geopolitical risk is back with a bang due to conflict in Ukraine, the Islamic State insurgency in Iraq and Syria, the politics of anger in Europe and the collapse of oil prices, but partying financial markets have barely registered it, yet.
Before the annual talk-fest of business and political elites began on Wednesday in the Swiss ski resort of Davos, a World Economic Forum survey said the risk of international conflict had now overtaken concerns about the economy, disease or climate change as the biggest threat to business and countries.
Yet investors drunk on cheap central bank money have driven stock prices in the United States and parts of Europe to near record heights, apparently oblivious to dangers near and far.
ECONOMIC GLOOM
That euphoria will be tested this year, especially since the International Monetary Fund has just cut its global growth forecasts for 2015 and 2016, China's economy is slowing, Russia is in a tailspin, and much of Europe remains in the doldrums.
To be sure, the rouble has lost half its value against the dollar since last June due to Western sanctions over Ukraine and tumbling oil prices, while the Swiss franc has soared by more than 14 percent since the Swiss National Bank gave up costly efforts to defend an exchange rate cap against a weakening euro.
Volatility may be rising, but the markets have not yet priced in the scale of potential turmoil.
“Taken together, the regional disputes in the former Soviet Union and Middle East have raised the spectre of a return to conflict over borders and territory, a risk compounded by fears that collective defense agreements such as NATO ... no longer retain their relevance,” said Tina Fordham, chief global political analyst at Citi.
“From the grass roots to the geopolitical, the global system is under immense pressure. In some places, it is cracking.”
SUCCESSIONS, BORDERS IN DOUBT
In the Arab world, uncertainties range from a succession of ailing rulers in Saudi Arabia, Oman and Algeria, to the widening tremors caused by bloodshed in Iraq and Syria that has called Middle East borders into question, sucked in outside powers and fuelled acts of violence on Europe's streets.
Even a possible diplomatic breakthrough to curb Iran's nuclear programme could create as much tension as it defuses, by bringing Tehran out of economic and political isolation to the dismay of Sunni Muslim states across the Gulf.
US Secretary of State John Kerry and Iranian Foreign Minister Mohammad Javad Zarif will bring their intensive nuclear talks to Davos, where they will meet on the sidelines in a race to craft a deal before the US Congress can enact new sanctions that could derail the negotiations.
“The risk ... is that a deal with Iran comes too early because the Saudi leadership of the Gulf Cooperation Council, the main adversaries of Iran, hasn't done the necessary to reach out to Iran in the way the Gulf needs,” said Florence Eid, chief executive of Arabia Monitor, a London-based consultancy.
Gulf Arab oil producers can afford low oil prices for a while without having to cut sensitive public spending at home, but it may make them less willing to go on bankrolling Egypt's army-installed government on the current scale.
If oil revenue stays low for a prolonged period, spending cuts could lead to social unrest from Algeria to the Gulf.
LOSS OF CONTROL
Europe faces potential worsening instability on its eastern flank and political upheavals in its southern rim.
Despite engaging in intensive diplomacy, Russia shows no sign of ending its support for separatist rebels in eastern Ukraine after it seized and annexed Crimea last year, triggering escalating Western sanctions.
President Vladimir Putin and his top lieutenants are staying away from Davos this year, but Ukrainian President Petro Poroshenko will use the forum to appeal for Western financial and political support for his country on the brink of meltdown.
Western officials say they have no way of knowing whether Putin intends to widen the conflict to other former Soviet areas, keep it on a slow-burner to destabilise Kiev or seek a face-saving way out. But they see little sign that the growing economic price of sanctions is softening his stance.
Although EU ministers agreed this week there were no grounds to ease sanctions, differences among European nations may widen as the deadline for renewing the measures approaches in July.
TOO MANY CRISES
Jean-Marie Guehenno, a former head of UN peacekeeping who now heads the International Crisis Group think-tank, said there were so many crises and so many powers involved that it was ever harder for world leaders to focus and engage.
“There is essentially a loss of control,” he told Reuters.
“The United States is no longer so eager to play the benevolent sheriff,” Guehenno said. “It will remain the overwhelmingly dominant military power, but at a time of growing doubt about what that power can deliver and whether there is the will to use it.”
He questioned whether Moscow was in full control of pro-Russian Ukrainian rebels fighting against Kiev and said instability from the conflict could spread into Russia itself.
On the brighter side, he said concerns about a potential clash between China and Japan, which flared at last year's Davos session when Japanese Prime Minister Shinzo Abe drew a parallel with the eve of World War One, had eased. Both countries seemed determined to prevent incidents escalating out of control.
In the European Union, the rise of hard-left and far-right populist parties opposed to austerity and demanding debt write-downs threatens the mainstream policy consensus that has prevailed since the euro zone crisis began in 2010.
Greece's far-left Syriza party is poised to win a general election on Sunday and become the first such radical group to enter government in the 19-nation single currency area, although polls suggest it may need a moderate coalition partner to rule.
Citi's Fordham said despite sympathy for Syriza across the euro zone periphery, scarred by mass unemployment, pay and pension cuts, she did not expect far leftists to gain power anywhere else in Europe.
A German media campaign highlighting the alleged dangers of the European Central Bank’s planned government bond-buying programme escalated on Monday, with a leading tabloid newspaper telling readers the euro could be “dramatically devalued” if the plan goes ahead.
The salvo by Bild comes as Mario Draghi, ECB president, faces growing criticism of the proposals ahead of the bank’s crucial board meeting on Thursday, where it is expected to approve quantitative easing. Expectations were reinforced on Monday when French President François Hollande said the ECB will “take the decision to buy sovereign debt, which will add significant liquidity to the European economy”.
While Mr Draghi says QE is needed to stave off the threat of deflation in the eurozone, the German government led by Angela Merkel, the chancellor, believes the programme will not work and could burden taxpayers in Germany and elsewhere with heavy potential losses. The government’s views are widely shared by a sceptical German public.
Mr Draghi has responded to the criticism with a charm offensive, giving rare interviews to two top German newspapers and preparing to dilute his programme.
The ECB is expected to take account of German concerns about shouldering other countries’ potential losses and announce that ultimate responsibility for bond-buying will be divided among the 19 eurozone national central banks. However, his moves have done little to silence his German critics.
Hans-Werner Sinn, head of the Ifo economic institute and one of Mr Draghi’s toughest opponents, took to the airwaves on Monday to say that the proposed burden-sharing would not spare German taxpayers from bailing out weaker eurozone states.
Central banks in, for example, Greece, Ireland and Cyprus, had already given out loans far above “normal limits” and so were already borrowing from the ECB system, he said, adding that a new programme could increase this collective burden: “The result is that we are liable because, on balance, we give them loans via the ECB system by buying government securities. And if [the central banks] themselves are broke, they can no longer pay the loans.”
Nor could the troubled government of a bankrupt central bank come to the rescue: “If the state itself is broke, it cannot stand in for the national central bank anyway,” Mr Sinn said.
Bild said many were worried a weaker euro would reduce the pressure for reform in “crisis-hit countries such as Spain, Greece, Italy or France”. The paper quoted Anton Börner, president of BGA, an exporters’ association, as saying: “The so-called warm-water countries must finally clean themselves up properly. But they will never do this with a low euro. They only understand the tough language of the capital markets.”
Frankfurter Allgemeine, the quality broadsheet newspaper, also expressed doubts about whether QE would be effective. Under the headline, “No, Dr Draghi,” Gerald Braunberger, a leading columnist, said QE would not work, adding: “New American studies show that the positive effects of buying government bonds are very probably exaggerated.”
He also quoted Sabine Lautenschläger, the German ECB executive board member, who has said QE should a be “a last resort of monetary policy”.
Ms Merkel on Monday played down the significance for the eurozone of the coming ECB decision on QE and of Sunday’s Greek elections.
Even though the chancellor has often said that the euro crisis is not over, she said: “I would not talk about a decisive week for the euro.”
There was a crumb of comfort for the ECB in Handelsblatt, Germany’s leading business newspaper, which was one of two papers — along with the liberal Die Zeit — to secure a Draghi interview.
Bert Rürup, head of the Handelsblatt Research Institute, warned against German “monetary policy chauvinism” at the ECB, arguing that the ECB must make policy for all eurozone members, not individual countries, and that the “ECB council is not a clearing house for national interests in proportion to the economic significance of individual states”.
However, Mr Rürup’s main point was not to endorse QE but to promote a drastic cut in the ECB council, which has 21 voting members, to weaken the link with the representation of individual countries.
Saudi Arabian Oil Minister Ali Al Naimi has asked why he should be responsible for cutting output while U.A.E. Energy Minister Suhail Al-Mazrouei said non-OPEC producers should reduce "irresponsible" production. How can that be? How can American production be 'irresponsible' in the land of the free (money). Well, as the following chart from Bloomberg shows, perhaps OPEC members have a point...
As Bloomberg's Chart of the Day shows, crude production in the U.S. increased 75 percent over the past 5 years while output from the Organization of Petroleum Exporting Countries grew 5 percent.
Canada boosted supplies by 42 percent while Brazil pumped 24 percent more, according to data from New York-based Energy Intelligence Group.
“The biggest contributor to the glut has been the rising output in the U.S., which has driven up global supplies,” said Kang Yoo Jin, a commodities analyst in Seoul at NH Investment & Securities Co.
“OPEC producers can’t be completely free from taking the blame as they were the ones who let U.S. shale oil players enter the market by limiting supply and keeping oil at $100.”
* * * However, what we find most intriguing is the inflection point in US production came at a coincidentally (because to claim causality would be ridiculous, right?) crucial time for the Federal Reserve as it went all in on unlimited open-ended money-printing which crashed the cost of funding for any and every project no matter how non-economic through-the-cycle.
Perhaps this post should be re-named "A Fed-Induced Mal-Investment Boom Busts In Real-Time"...
ReutersGeopolitical risk looms large thanks to conflict in Ukraine and the Islamic State insurgency in Iraq and Syria, among other factors. File photo: Valentyn Ogirenko.
