Episode Transcript
Alex: All of this collectively has really led to this big geopolitical shift where you have a lot more vulnerability. So these normal cycles end up having a much bigger impact.
Jenny: Hello, and welcome to FTSE Russell Convenes. I'm Jenny Cosco, and I'm excited to talk to Alex Kazan from Eurasia Group today on the new geopolitical landscape. Alex, welcome. Thanks so much for having me. Thanks so much for joining us. So let's start with the new geopolitical baseline. Over the past 10 years, investors have faced a series of shocks from the Ukraine war to energy security. In your view, which of these geopolitical risks are cyclical and which are secular?
Alex: I think fundamentally, almost all of the challenges that the geopolitical challenges that the business community and markets have faced are fundamentally structural in nature. You have cyclical elements, right? The normal electoral cycles in places, different conflicts. But underpinning all of it is a deep structural shift in the geopolitical landscape, and it's helpful to take a quick step back to sort of explore how we got there.
A big part is the emergence of China as a major economic, commercial, and security power over the last 10 years or so. China's emergence really has challenged the rules of the road, if you will. Those rules were largely built by the US in the post-war period through institutions that sort of underpinned what we think of as the global financial system, global trading system, the global economy. At the same time, the US over that period has really stepped back. At the same time, less leadership of those institutions, much more focus on domestic political challenges, problems, the deep divisions that we see in the US right now. All of that has led to, and I would add, the advent of social media is something that has accelerated this. And Covid, of course, really accelerated that loss of trust in institutions in the US and other Western powers as well. But all of this collectively has really led to this big geopolitical shift where you have a lot more vulnerability. So these normal cycles end up having a much bigger impact. So take an election in the US, for example. We've seen a big erosion in checks and balances on executive power. So when we have electoral shifts in the US, it's going to lead to a lot more policy volatility.
This has a couple of other implications, I think, from an investment standpoint. One of those is that the time horizons that we think about for different conflicts and issues and geopolitical challenges is longer. There's sort of a long tail to these things. The second is that the sources of risk has really shifted. We used to think of geopolitical risk as something that came primarily from emerging markets, right? Places with more instability, less developed economies. That's not true anymore. Now, when we look at sources of geopolitical risk, it's the US, it's China, it's Europe. And when you have the biggest economies in the world as sources of geopolitical risk, it creates bigger challenges.
And the last thing I'd say on this from an investment perspective is it really requires us to look differently at risk premium. Where do we apply them, over what time period and at what level is a new challenge, right? This is something relatively new to the investment landscape to think of that kind of risk coming from these sources.
Jenny: So let's talk about the US, traditionally a source of geopolitical stability, with some commentators now saying it is the largest source of geopolitical instability. Can you talk to us about the domestic drivers for that and also how global investors and other stakeholders are looking at the US at the moment.
Alex: So I agree with that premise. I think it's undeniable that at this point, the U.S. is now the largest source of geopolitical risk and instability in the world. And that's hugely consequential, right? I mean, you have the biggest economy, the center of global capital markets, the center of the dollar-based financial system, now the biggest source of risk. That's obviously going to have an impact. Again, looking at how we got here, it really relates again to the US in the post-war era built all these institutions around which our financial system is centered. And that withdrawal, that pulling back support from the further growth and development of those institutions has fundamentally left a vacuum. You also have major domestic sources of that lack of trust in institutions, political partisanship, the idea used to be that foreign policies, that the domestic politics stopped at our borders, right? We did not, we had much more coherence and cohesion and less partisanship around foreign policy. That hasn't been true for a while, but it's certainly not true today. But I think fundamentally, it's about the eroding trust in both domestic and global institutions that the US has played a role in.
So, what has that led to? A lot more policy volatility, right, shifts, tariffs are a great example. Tariffs had not been on the policy menu of the US for a very long period of time. They have gone back, and this is not just about the Trump administration, right? We've seen a big strengthening of executive power in the US with an erosion of checks and balances. Congress plays a less central role. The courts have been diminished a little bit. That's not a partisan thing. that's not just about the Trump administration. I think you will continue to see that. So that means that structural erosion means that the normal political cycles are going to be exacerbated. And you're going to see that in big shifts in policy, which leads the rest of the world to look at the US and say, I don't know what I'm getting as much. I have less trust in policy continuity. I don't understand your approach to alliances as much as I used to. And that's leading to what I think of as hedging behavior, right? Different countries around the world, yes, obviously you want to still trade with the US. You want to invest in the US. We still have the most innovative companies, the most vibrant, dynamic business environment, but that risk premia is higher. And so you see a lot more hedging behaviour. Hedging may mean doing more deals with China, even if you're taking on some national security risk. It might mean diversifying your supply chains and your export markets.
Jenny: So let's talk about US foreign policy, which traditionally has focused outside of the Western Hemisphere. During the past few months, we have seen activity in Venezuela and an increased focus on the Western Hemisphere. How do you see that playing out over the next year?
Alex: Yeah. So this is not accidental. This is very intentional by this administration. Last year, they released, as every administration is required to, a national defense strategy. And normally, this makes for pretty dry reading. But when I read it, I was sort of flabbergasted. I mean, it really laid out a lot of ambitious things that the administration has subsequently tried with varying degrees of success to accomplish. A big surprise was the centrality of the Western Hemisphere. And the basic idea is that in a dangerous world, security starts with our hemisphere. And that explains a lot of the focus that we've seen up until the Iran war of this administration on hemisphere security issues, some of them somewhat far-fetched, like Greenland, some of them quite successful, like the regime change in Venezuela.
There will be questions as to whether Venezuela remains a success. We'll have to see if the investment in the energy infrastructure there from the private sector comes. But fundamentally, it looks like the biggest success so far in the Trump administration. I don't know if they can replicate that in other parts of the hemisphere. Cuba may be an area where we see much more pressure. Marco Rubio would love to have that as an accomplishment. We've also seen pressure on Mexico, and to date that's been fairly successful, with a focus on security coordination and collaboration around cartels, drug interdiction, that sort of stuff, and also getting Mexico to align more with the US approach on treating Chinese investment in some sensitive sectors as national security risks.
I think the big test and the most important for markets, and maybe a little bit underappreciated, is USMCA renegotiation, where right now things don't look great, and markets really haven't focused on this. But the business community is very concerned, given how important the North American economy is, not just the US economy is to some sectors, most obviously autos, but also energy.
Jenny: So turning to the Iran war, a lot of investors have focused on some of the short-term activities and implications. What's your sense as to the longer-term implications of what's going on in Iran right now?
Alex: Yeah, I think they're massive. And not to overstate it, but I think this war is fundamentally leading to geopolitical realignment, particularly in the Middle East, but with global implications. In the Middle East, you're seeing the erosion of OPEC. You're seeing the GCC effectively become less important as a political unit. The Emirates turning more toward a very clear alliance with the US and Israel to some extent, and other regional powers trying to play more of this hedging role. But I think long-term, you have a couple of big implications. One, it's going to be an accelerant toward the rest of the world, ex-US, looking for other non hydrocarbon sources of energy. The second and related point is that this is actually good, I think, from a long-term perspective for China. China will benefit from that demand for solar, for electricity storage, for batteries, for the full stack of alternative energy.
I also think that China has been positioned here as a somewhat more responsible stakeholder. And from the outside looking into the US, I think a lot of people now view the US as less predictable and China actually more predictable. That has implications. It doesn't necessarily mean that the whole world is going to flock to want to trade more or invest more with China, although I think there will be more demand for Chinese solar, battery, things like that, and other parts of the emerging technology stack as well.
Jenny: So let's end on China. There's been obviously a lot of geopolitical volatility that can create disruption, but also opportunity. And we've seen the rise of China over the past several years. What are the areas where it's going to benefit from the current geopolitical landscape? What are the structural headwinds? And then what are your thoughts on US-China relations?
Yeah, those are the three really important ways to look at China right now. I think in terms of the current geopolitical environment and how China is positioned in And I'm generally a net beneficiary of this, right? As I said, benefits from shifts in energy demand toward more renewable, more solar. In terms of its advantages and disadvantages in technology, there's a lot of focus on the fact that the US still leads in emerging frontier models in AI. That's true. But China does them well enough, and China does very well in the implementation, right? The robotics, EVs, how it actually fuels manufacturing and things like that. So I think China is well positioned in those two areas, benefiting from shifts in energy demand and the implementation of AI into real world activities.
On the challenges, we have to, you know, it's not all positive for China. I mean, there are serious, serious structural challenges. One of them is that there are limits to how much the rest of the world can shift to China. China has structural overcapacity in manufacturing. It's been exporting a lot of that around the world. In a lot of places, they may want to hedge their exposure to the US, but they realise that there can be real economic dislocations if China just sort of dumps its overcapacity onto the rest of the world. I think that's particularly relevant for Europe, where you've started to see some tariff barriers start to go up, and some political sensitivities around the auto sector in particular.
One piece of, I think, constructive news or recent developments is that the US-China summit between, or probably more accurately described as the Xi-Trump summit, because it really is a relationship driven by personalities and individuals right now. The good news is that not much happened, right? It was about stability. It was about agreeing that the big persistent issues in the relationship, and there are many, let's keep them at a technical level right now. Let's keep the high-level relationship stable. I think that's going to persist for some period of time. They've agreed to meet again in the fall. So that is a bright spot in this generally fragmented and challenging geopolitical environment that you can expect some more stability out of the US and China relationship.
Jenny: Alex, thanks so much for sharing your perspectives with us today. Thanks so much for having me.
