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Markets Blind to Geopolitical Risks?

09/09/2014 12:30 BST | Updated 08/11/2014 10:59 GMT

Monetary blinders

Neither stock markets nor oil prices have responded strongly to geopolitical unrest. On the contrary, recently stock indices have been in high spirits as oil prices dropped.

Of course, weaker oil prices and disappointing global economic data are connected. And stock prices are mainly rising because monetary policy continues to be ultra loose and due to speculation that the ECB will opt for QE.

Nevertheless, political turmoil undermines stability and predictability and precisely these factors are vital to economic growth and globalization. Their absence endangers international trade and capital flows. Next, the foundation of worldwide economic interdependence will become porous and crack. Especially since the credit crisis has set a process in motion whereby countries tend to turn inwards and/or take refuge in regional blocs.

West unrealistic or simply hypocritical?

Once abundant liquidity dries up, the impact of the geopolitical forces - like the crises in Ukraine and the Middle East - will become more apparent. Europe's (and the West's) dealings with Ukraine shows that many western countries think that in the 21st century, power politics (realpolitik) has been superseded by liberal thinking. "Europe can be kept whole and free on the basis of such liberal principles as the rule of law, economic interdependence and democracy," is the credo of the West, according to the political scientist John J. Mearsheimer. Roughly speaking, the western response to Russia's actions against/in Ukraine can be summarized as, "This is not the way we interact in the 21st century." The big problem is that in most of the rest of the world, power politics trumps liberal principles.

Apart from the fact that the liberal thinking in the West can be naïve, it comes across as hypocritical. For in reality, power politics is often the preferred policy stance. An example are the close ties between the West and Saudi Arabia. Recently, arguments have been advanced that it might be a good idea to collaborate with Assad now that ISIS poses a far greater threat to the western world than the Syrian dictator.

Lack of insight and empathy

Some would say that hypocritical is too harsh a word. The very least that can be said of the West is a remarkable lack of insight (and empathy) in its contact with Russia. After the fall of the Berlin Wall, NATO promised Moscow that it would only add East Germany to its ranks. Subsequently (during the period 1999-2009), it blithely invited the Czech Republic, Hungary, Poland, Bulgaria, Estonia, Latvia, Lithuania, Romania, Slovakia, Slovenia, Albania, and Croatia to become part of the Alliance. It did not stop there but held out the same prospect to Georgia and Ukraine. In addition, the EU initiated the Eastern Partnership initiative.

During the conflict with Georgia in 2008, Russia drew a line in the sand but that did not deter the West. Not helpful was that US funded organizations openly stated that Russia would be next in line for a revolution. Then there was the leaked telephone conversation between the US Assistant Secretary of State who seemed to suggest that she could single-handedly decide who would take office in Kiev.

I am not saying that Russia has the right to do what it does. But there was no reason for the West to feign surprise. Also because Ukraine has been an essential buffer state for the Russians for centuries. Both Napoleon and Hitler sent their armies through Ukraine when attempting to bring Moscow to its knees.

Unpredictability as strategy?

Putin's strategy is characterized by improvisation and unpredictability. But one thing is certain, Putin likes power politics and he is no liberal. Another given is that Russia has little to gain if it occupies the eastern part of Ukraine. A large majority in the area does not want to join Russia. Russia has a mediocre army; it would have a hard time subjugating the eastern part of Ukraine. Even if it wanted to, the Russian economy is weak and occupations are very expensive. Furthermore, earlier occupations were not exactly successful; see, for example Afghanistan and Chechnya.

Putin aims for a "frozen conflict", analogue to developments in Abkhazia and South Ossetia. His highest priority will be to steer Ukraine away from the West. Kiev would not necessarily be at Russia's beck and call but from Moscow's perspective Ukraine's membership of the EU and - most particularly - NATO would be beyond the pale.

Extreme ambitions

Besides Ukraine, IS remains the biggest global geopolitical threat. It wants to constantly expand its territory and access the associated (mineral) resources. In addition it aims to become top dog among international jihadists and to seek confrontation with the West (for ideological reasons and to make converts).

Presently, the movement has to fight on many fronts against a multitude of enemies: troops from Iraq, Syria, and Lebanon as well as Iraqi and Lebanese Shia militia forces, Kurds from Iraq, Syria, and Turkey as well as rival Islamic and secular Syrian groups and the US air force.

The West cannot just fight IS in Iraq. The extremists have "abolished" the borders between Syria and Iraq so to tackle the movement, the anti-IS alliance will need to be move into Syrian territory as well, which could require a pact with the devil incarnate, President Assad.

There is no doubt that IS will be a very hard nut to crack. Presently, it is in control of a third of Syria and Iraq and when it suits him, Assad will give IS more room for maneuver. Whether Bagdad will form a united front is doubtful; even if newly appointed PM Haider al-Abadi inspires more confidence than his predecessor.

United front against Islamic State?

Moreover, there are doubts whether the Arab world is prepared to get tough with IS. Most Sunni states view Iraq through an Iranian and sectarian prism. The country is pivotal to the balance of power between Sunnis and Shia and thereby between the Arab world and Iran. If it is necessary to strengthen a Shia pro-Iranian administration in Bagdad in order to weaken IS, Arab states will think twice before joining the alliance against IS. The weakening of IS could also strengthen Assad's hand while many regard Syria as a detached post of Teheran. And last but not least, Arab states fear that IS will retaliate if they take up weapons against the extremists.

Although the terrorist movement has lost ground recently, IS cannot easily be wiped out. It has highly motivated and well-trained fighters whereas its enemies are far from united. Therefore IS will hang as a dark cloud above the markets for the foreseeable future.

US as safe haven

The Ukraine and IS crises are part of major geopolitical trends that already exist, which are slowly undermining globalization, the international world order instigated by the West, democratization, and open markets. These effects unfold gradually.

Still, once the Fed moves towards tightening, the aforementioned crises could send jitters through markets. Under such conditions, traditional safe havens will become very popular. Most of all in the US, which is farthest away from the hotbeds while US economic growth could be (reasonably) strong for another while.