2024, a High Geopolitical Risk
After 2023, an excellent year for risky assets despite the war in Europe and the Middle East and an increasing confrontation between the United States and China, it would be tempting to set aside geopolitical risk. However, alongside the issue of interest rates, geopolitics is likely to be investors' second major concern in 2024.
The United States tops the list of all geopolitical problems. The degree of polarization, dysfunction in many political institutions, and the likelihood that the election will be contested by two intensely disliked candidates all make it more or less inevitable. The dynamics of the Electoral College mean that the outcome could come down to razor-thin margins. Therefore, the result is uncertain, and its acceptance is not assured. Beyond that, various legal proceedings against Trump and the potential candidacies of several third-party candidates make the election even more challenging to predict. Moreover, either of the two favourites will be the oldest president ever at the end of their term. The risk of a health event that could change the entire election and its subsequent presidency is real but impossible to measure.
The political environment increases the likelihood that the current administration will do its best to stimulate the economy this year, which is positive in the short term but highly debatable in the long term. Some analysts argue the controversial thesis that the Federal Reserve's shift toward easier economic funding at the end of 2023 was motivated by the perception that Trump's election is a threat to the United States. They add that in the unlikely event that the Supreme Court confirms the decisions of Colorado and Maine disqualifying him as a candidate, the Fed could go back to ignoring politics and do its job, in other words, become more hawkish.
The U.S.-China relationship is another source of concern. However, analysts differ in their views here as well. Some say the risk has disappeared, at least in the short term. They believe that the domestic situations in both countries are pushing their leaders to de-escalate the conflict and carefully manage the decline in their relationship as they focus on domestic politics. The Chinese economy leaves no room for the ruling party to engage in military adventures. By reopening military dialogue late last year, both countries clearly wanted to reduce tensions.
The problem is that no U.S. presidential candidate is incentivized to be friendly with China. With likely increasingly passionate rhetoric, this exacerbates the risk of a sudden surprise from China. The fragile U.S.-China détente will likely be tested in the coming months.
Even though a hawkish stance toward China is largely bipartisan, the elections will lead to more assertive rhetoric toward Beijing. In these circumstances, an incident in U.S.-China relations could trigger a more incisive reaction.
A much more short-term risk is the election in Taiwan next week. Former Taipei Mayor Ko Wen-je represents the Taiwan People's Party (TPP). Current Vice President Lai Ching-te represents the Democratic Progressive Party (DPP). Finally, New Taipei Mayor Hou Yu-ih are the Kuomintang (KMT) candidate. The KMT has historically sought to improve relations with mainland China and promote economic, trade, and cultural rapprochement across the Taiwan Strait. The DPP, the ruling party and the favourite, is the political party that favours greater independence and autonomy for Taiwan from mainland China. Lai Ching-te emphasized in his campaign that he had no intention of upsetting the modus vivendi. However, if he wins, China will not be able to remain without a reaction. The response will probably be symbolic, perhaps more economic sanctions or provocative military exercises like those that followed Nancy Pelosi's visit as Speaker of the House in 2022.
But everything is still being determined. Xi could use it as a pretext to integrate the island into mainland China forcibly. The Chinese population is hostile to Taiwan, which would divert attention from economic and social turmoil.
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A military attack on the island would be the most significant geopolitical event since the fall of the Soviet Union. The world would face the greatest danger since World War II if it turned into direct armed conflict between the United States and China. Both sides know it. For this reason, many argue that it will not happen. U.S. support for Ukraine is likely a warning against Chinese aggression, even if the current debate in Congress over aid to the country could change that calculation.
The reality of the end of globalization and the beginning of regionalization that began in 2018 during the Trump era involves declining international flows of capital and goods and, therefore, less growth. This should mitigate the deleterious effects of globalization, such as inequalities in the Western world, but also end its great benefits, including how cheap Chinese labour has contained inflation for decades. It also puts pressure on many emerging countries. Geopolitical risks tend to increase rather than decrease inflation, as they disrupt supply more than reduce demand. The case of oil is a perfect example.
We are witnessing the beginning of a strategic reallocation of specific industries. This means significantly reducing risks related to critical and emerging supply chains and associated innovation pipelines for Western countries by 2030. Companies are redirecting their foreign investments. However, this is with risks. Disputes between the United States and China over access to technology, especially when it has defence implications, are a good example. The end of complementarity and greater countries' independence from others is a risk. Given the current economic flows between China and the United States, neither country is interested in a major conflict. But if there is too much decoupling, conflict becomes an option.
There will be winners in this process that will change the economic face of the world. In the North American bloc, Mexico, also holding a presidential election, is an obvious candidate to benefit from "friend-shoring" despite its problematic relationship with Trump. The same goes for some Eastern European countries, like Slovakia. The prospects for increased capital expenditures and investments as the United States and Western Europe seek to rebuild their manufacturing base are optimistic.
The conditions created by the fall of the Berlin Wall and China's opening to capitalism will gradually be reversed. Governments will become more interventionist to limit increasingly prevalent social movements. By force of circumstance, this world will be more inflationary and, therefore, will require higher interest rates. Less trade flows also mean less growth, less profit, and, therefore, more complicated stock markets.
The emergence of BRICS represents uncertainty and a challenge for the Western world. Saudi Arabia, Egypt, the United Arab Emirates, Iran, and Ethiopia joined the BRICS group on January 1st. To recall, the original BRICS comprised Brazil, Russia, India, and China, with South Africa joining them in 2010. The expanded BRICS have a combined population of around 3.5 billion people, with an economy worth over $28.5 trillion, or about 28% of the world economy. The geopolitics of commodities could change significantly. The hegemony of the US dollar could be tested.