Political risk has come home, and we must combat it

The past decade has upended my profession almost entirely. I work in political risk, and my job is to advise companies how to manage political and economic instability. A coup in Turkey, sanctions against Russia, unrest in Venezuela, debt default in Argentina – such risk events are the bread and butter of political risk analysts such as myself, and of political risk underwriters who offer insurance policies against such perils. Until recently, these risks occurred almost exclusively in emerging markets such as Turkey and Russia. No one ever asked us to analyze the politics of the Netherlands. No one ever tried to buy political risk insurance against civil war in Canada. To have done so would have been preposterous. Indeed, the absence of political risks from the “advanced economies” of North America, Western Europe and Japan was almost definitional. The certainty that politics would not impact business operations was what made these countries safe havens for investment; it was part of the formula that enabled these countries to become, and remain, rich. The Eurozone crisis changed all that. Greece’s sovereign default in 2012 was the first default by a rich, industrialized country since World War II. (And even during World War II, defaults were rare.) It was an event that most people had considered inconceivable. For Greece, the economic costs of political uncertainty turned out to be enormous. Perhaps hoping to stave off cognitive dissonance, in 2013 Morgan Stanley Capital International duly reclassified Greece as an “emerging market.” Such risks are not limited to Europe. In 2011, the US lost its AAA debt rating from Standard & Poor’s, in...

Why a federal Ukraine is a worst-case scenario

Ahead of US-EU-Russia talks on the future of Ukraine on Thursday, pro-Russian protesters – possibly assisted by Russian special forces – have escalated their disruptions in Eastern Ukraine beyond Crimea. While media coverage is understandably alarmist, these disruptions are not necessarily worrying signs. Ahead of negotiations there is always a rush by the negotiating parties to establish facts on the ground to support their positions. This is why Israel inevitably pushes forward with building settlements just ahead of negotiations with Palestine; is why both sides in Sudan’s conflict ramp up hostilities each time peace talks are scheduled. It does not mean the talks are falling apart before they have started. It’s just good strategy. The fact on the ground that Russian President Vladimir Putin hopes to establish prior to talks is the destabilization of more of Eastern Ukraine. This way he will have something to give up, in exchange for what he wants: a federal Ukraine. This is what Russia has been proposing as an acceptable compromise for Ukraine even before it invaded and annexed Crimea. Is also very worrying, as a federal solution is a worst-case scenario for Ukraine. Some may feel that it is a small price to pay in exchange for peace. Russia, the EU, and the US can play their games of influence in a federal Ukraine, jockeying for the sympathies of individual provinces, rather than playing the higher-stakes games of sanctions and energy threats, which have the potential to disrupt the fragile recoveries now emerging in the EU and underway in the US. The problem with the federal solution is that it undermines the...

The Eurozone’s (and Japan’s) deflation problem

I tend to be bullish on Europe – partly as a corrective to the mass of commentators who too early wrote off the crisis in the Eurozone as irresolvable. This optimism has been justified by the recent run-up in European equities, with developed European countries (Germany, Ireland, Finland…) constituting four of the five best-performing stock markets of 2013, when measured in US dollar terms. That said, a spectre is now haunting Europe – the spectre of deflation. The problem with deflation is that it makes the value of savings grow, which encourages people to spend less. If prices are falling, a penny saved is more than a penny earned, because, if you do not buy that TV set (for instance), not only will you have saved your penny, but the TV set will be cheaper in a few months, so you are actually getting a return on your patience. Hence deflation encourages people to save, which reduces demand. The TV shops in response reduce the prices of TVs even further, in an effort to get you to buy. Which implies yet more deflation. A few rounds of this, and you have the dreaded “deflationary spiral”, producing not only deflation but a serious contraction in consumer spending and hence real economic activity. Scenarios run by Oxford Economics on the potential impact of sustained deflation in the Eurozone are not pretty, suggesting the economic bloc would be pushed back into recession. In response to such concerns, Germany’s Bundesbank has recently softened its opposition to quantitative easing, suggesting that radical measures to combat the threat of deflation may be forthcoming. This announcement has widely...

Ukraine is Europe’s struggle, and it is likely to win

There has been a great deal of commentary regarding alleged blunders that have led us to the current position in Ukraine (as I write this, the Ukrainian province of Crimea has voted to join Russia, and Russia has recognized Crimea’s independence, which could be a prelude to annexation). In reality, the only serious blunder was committed by the new, interim government of Ukraine immediately after taking power, when it declared that Russian would no longer be an official language of the country. This gave Putin to a pretext to act. Chalk it up to inexperience. The old hands at the table – Russia, the EU, and the US – have played their positions well. First Russia. Many say Putin is a reckless gambler; and indeed that is true. But he has had no choice but to gamble. Losing Ukraine so soon after asserting Russia’s position on the world stage via the Sochi Olympics was a humiliating blow. Invading Crimea while pretending the troops involved are not Russian and offering Crimea a referendum on secession are awkward ways to cover up a violation of international law. (Perhaps he will next offer Chechnya a referendum on secession from Russia? This is the kind of precedent Putin presumably would rather not have established.) That said, it appears that Putin may succeed in turning his humiliating loss in Ukraine into a partial victory, by gaining Crimea in some form, with little blood on Russian hands. Once the government of Yanukovych had fallen, that is probably the best outcome Putin could have hoped for. It is thus a bad hand played well, although Crimea...

Ukraine crisis reveals Europe’s strengths

Things in Europe do not seem to be going so well these days. The Eurozone crisis is a recent memory. European politicians bicker over bailouts or make reckless threats. Unemployment is high. The Swiss are voting out the immigrants and in many European countries right-wing parties are on the rise. But the European model remains appealing. So appealing, in fact, that people in Ukraine are willing to risk their lives for it. Demonstrators in Kiev, picking a moment when the world’s eyes are on the region, have marched on their government, resulting in harrowing scenes of violence. Admittedly, there are many different factions involved in the protests now. But the starting point, about three months ago, was the Ukrainian government’s debate over a trade agreement with the EU. And the protests escalated dramatically when the government instead accepted a deal with Russia. Make no mistake: the violence is not just about trade agreements. Or rather, much of it is, but these are no ordinary trade agreements. As the intensity of the protesters’ commitment suggests, this is one of the most important struggles taking place in the world today. It is, in the phrase promoted by the European Union and taken up by numerous Ukrainian politicians, a “civilizational choice”. The trade agreement Ukraine signs will shape the country’s destiny. To see why this is so, take a look at the below graph. This shows the incomes of countries joining the EU compared to one of the EU’s richest members (Denmark). What is striking is that the rising lines of incomes in Eastern Europe are almost parallel – despite great differences...