Geopolitical conflicts, from Ukraine to Syria, are connected to economic pressures, said Philippa Malmgren, president and founder of DRPM Group, at the 2014 European Investment Conference. Malmgren argued that financial analysts are largely unable to analyze this connection and financial markets fail to respond to geopolitical developments until they culminate in graphic headlines.
So, how are the two interconnected? Malmgren explained that an increase in the price of food and energy in a country can cause social unrest and can also raise concerns about food and energy security; governments may then be compelled to take bold steps to control the food and energy supplies for their populations. In addition, she believes the near skirmishes between fighter jets and naval ships of major military powers, such as the United States and China, are not random events — they are rooted in such concerns about national security.
Malmgren has had the opportunity to observe both politics and financial markets at close quarters. Her career includes stints as financial market adviser to US President George W. Bush and as deputy head of global strategy at UBS. Interestingly, in an instant digital poll, a clear majority of the investment industry professionals at the conference agreed that the investment profession needs to strengthen its ability to analyze geopolitical risks (71%).
Malmgren argued that Western governments are deliberately defaulting on their mountains of debt without it being formally called a default. She claimed they are doing so by manufacturing inflation through unprecedented monetary expansion, thereby lowering the purchasing power of creditors, which include some of the most powerful countries in the world, most notably China.
But are we really experiencing inflation at a time of warnings about deflation? Malmgren contended that inflation is not being reflected in the statistics published by central banks in the West but it is very much there. The rising prices of key items — such as wheat in the Middle East, pork in China, and onions in India — are causing ripples in those societies. She also believes that it is a misconception that inflation does not matter in the West, adding that the top issue in the United Kingdom in the coming 2015 national elections is the rising cost of living; though inflation indicators published by the Bank of England may not suggest the same.
Malmgren argued that in response to the Western default on debt through manufactured inflation, creditors, including China, are going about buying strategic assets around the world, including those in food and energy. She stated that they are also aggressively pursuing their claims to disputed territories, such as in the South China Sea, a major source of the global fish supply — highlighting that when China recently established its new “Air Defense Zone,” the United States immediately deployed its B52 bombers as a countermeasure. Malmgren also highlighted that Russia is unwilling to see Ukraine join the European Union, a move that would decrease its influence on one of the largest grain-producing countries in the world.
Malmgren suggested that the nature of geopolitical conflict is changing, as boots are no longer necessarily required on the ground. Modern-day conflicts are taking place in space, cyberspace, and in monetary policy. China’s military trains to operate without GPS and China is testing destructive anti-satellite systems. Why? Malmgren believes it is because by controlling satellite systems, an army can deny its enemy the ability to operate the weapons that rely on satellite technology. She added that cyberhacking has emerged as a tool of modern warfare — the laptops of high-ranking US officials have frequently been hacked inside the Pentagon. It’s not just satellite technology and cyberhacking, however, monetary policy itself has become a tool in conflicts, Malmgren remarked.
But why is it that financial analysts are unable to fully notice and analyze such developments? Malmgren pointed out that many financial analysts today have grown up in the post–Cold War era and have not observed any war between large military powers. They have also not experienced the ravages of inflation. These analysts need to read history to realize that what they have experienced is not “normal,” said Malmgren. It is normal for the world to experience substantial inflation, major geopolitical conflicts, and changing borders — events in which fortunes are won and lost.
So what should investment professionals do to manage geopolitical risk in their investment portfolios? Malmgren does not think the answer is holding gold, largely because governments can expropriate gold in one way or another. Having said that, she did point out that the record high prices for diamonds suggest that people are turning to them to protect their wealth. Her principal advice: to manage geopolitical risk, buy strong business brands that can pass on the effects of inflation.
Malmgren’s talk at the 2014 European Investment Conference was broadcast live online. You can watch the archived footage here.
If you liked this post, consider subscribing to the European Investment Conference blog.
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.