The Asian temperature is rising
Weakening growth in China and other emerging economies and geopolitical tensions are the biggest risks to financial markets. Those two are dangerously interconnected right now.
The repercussions of the Ukraine crisis will reverberate outside Europe. In Asia, the sovereignty over various islands, islets and reefs is disputed. Putin's land grab may be an inspiration to some Asian rulers bickering over the Senkaku/Diaoyu, Paracel, Pratas and Spratly Islands and the Macclesfield Bank and Scarborough Reef.
Asia will become less stable in the years ahead. There seems to be an unbridgeable gap between China and Japan. The two Asian countries do not see eye to eye on military armament, human rights, Taiwan, regional security, international rule of law etc. The relationship between Japan/US and China is increasingly competitive and the same applies to many other power balances in the region.
A G-Zero/G-X world
China in particular is bound to feel increasingly uneasy about its position within the current global order. After all, this creaking edifice has been set up - and is still largely dominated by - the West. For the moment, I do not see any solutions to the most entrenched Asian conflicts. The least harmful option seems to be that these disputes are managed and contained on an ongoing basis.
Even that will be difficult. The changing geopolitical landscape and the fragmentation of the international community is complicating global governance. The world lacks clear structures while constantly changing coalitions of countries, international institutions, businesses, movements, and NGOs are trying to get to grips with a raft of tricky problems ... From pollution to territorial conflicts; from terrorism to attempts at governing the Internet.
Until recently, western observers assumed that countries mostly derived security interests from their economic interests. Putin has made it clear that this may be a naive hypothesis. For a long time to come - if not forever - preoccupation with power will play a prominent role in international relations. In conjunction with national pride and prestige, this could send tensions sky high.
Asian war a realistic prospect?
Although a real war seems miles away, professor Graham Allison talks about the Thucydides Trap in his article titled 2014: Good Year for a Great War?. The likelihood of war increases greatly when a rapidly rising power competes with an established power. In the past 500 years, 15 such situations have occurred; in 11 cases, the result was war. Sometimes the complicated dealings between various allies made the situations more explosive.
China could start testing the waters. Is the US really prepared to put its money where its mouth is? On paper, it has provided safety guarantees to the Philippines and Japan but what if this leads to bloody warfare? The commitment of the US has been in doubt before. The disbelief will only increase now the US has embarked on what Niall Ferguson calls geopolitical taper. The global financial crisis has reinforced the impression that the West is losing strength. In 2007, the US economy was four times the economy of China. In 2012, it was "merely" twice as large. This could make China reckless. Especially as it is obvious that the West is fairly powerless to stop Russia's brazen push.
Experts also worry about Japan under Prime Minister Abe, who has a nationalistic bent and wants to rewrite the Japanese constitution to give Japan a "normal" army. In many ways, such a change is defensible but it is worrying in combination with Abe's visits to the Yasukuni Shrine and the fact that he is just paying lip service to the Kono and Murayama declarations.
The intersection of geopolitics and economics
Geopolitical tensions can rise in any case, once countries are in choppy economic waters. Undoubtedly, Putin will have considered Europe's weakened position before he decided to annex Crimea. After all, the EU is focused on its own economic crisis. It does not really have the time, money, or inclination to engage in expensive power games.
Things could go the other way as well: politicians playing the nationalistic card, making sure the country is united against a perceived outside enemy in order to divert attention from domestic issues. Japan may be in for a bumpy ride over the coming period, due to the increased VAT rate, disappointing wage increases, and lower-than-expected consumption data. If Abenomics turns out to be a disappointment Abe could bet on his nationalistic agenda.
Hard or soft landing?
If no soft landing occurs, Beijing could also exacerbate regional disputes. Opinions differ about the economic prospects of China. Some think it will manage to deflate the credit and property bubble in an orderly fashion. Recently, Beijing let the money market rates rise to show that it does not shy away from tackling excessive credit. Simultaneously, it is propping up state-owned companies. This approach is far from ideal, but it could pave the way towards gradual deleveraging instead of the severe shock of a hard landing.
Morgan Stanley is less sanguine. It's very concerned about excessive investment funded with excessive debt in China. A sudden collapse of asset values is likely as too many debtors are unable to meet their interest and debt repayment commitments. Interest payments on outstanding debts run to 17% of GDP (twice the percentage in the US in 2007). Ten years ago every invested yuan yielded one yuan in GDP growth; presently, four yuan are needed. Therefore growth could slow considerably. Should this happen, Beijing could take a more assertive geopolitical stance. Moreover, a growth slump would stoke unrest in other already restive regional economies. This will have a negative impact on the rest of the global economy.
A good year for what exactly?
The Dutch Central Planning Bureau calculated that an escalating Ukraine crisis would hurt global trade, increase energy prices by 10% and hit economic growth in Europe. Out-of-control conflicts in Asia will have far worse implications for the world economy. Another Great War is unlikely, but this could be a Good Year for Mounting Tensions with more geopolitical power games, a lack of decisive action by international institutions, a more cautious America and economic headwinds in Asia.Suggest a correction