Roland van den Brink: A tool for risk management in times of geopolitical uncertainty

Roland van den Brink: A tool for risk management in times of geopolitical uncertainty

Geopolitics

This column was originally written in Dutch. This is an English translation.

By Roland van den Brink, founder of TrigNum

Almost every week, the United States adjusts its import policy, resulting in geopolitical tensions. Regulators emphasise the importance of identifying possible consequences using scenarios. However, parameters such as returns, inflation and economic growth only paint part of the picture. Financial market developments can also be misleading.

In this column, I describe an approach that also takes into account sentiment within countries and point to a method for asking targeted questions.

Dual situation

Since April, there have been alarming reports about the American economy on an almost daily basis. The ports of Los Angeles and Long Beach, the busiest in the US, report that the number of incoming ships has fallen by almost half and that empty containers are leaving the ports more often than before. This has led to less work for truckers, dock workers and warehouse employees. Major importers such as Walmart have indicated that price increases are inevitable and that logistical congestion is leading to less choice for consumers. American farmers are now protesting as exports to China have fallen sharply and the costs of fertilisers, pesticides and agricultural machinery have risen.

However, such reports sometimes forget that the US economy is resilient and that the government has sufficient resources to mitigate a major downturn. America is home to the world's richest consumers. Although the US accounts for only 4% of the world's population, it consumes more than 25% of global production. In May, core inflation and the trade deficit fell in the US, and consumer confidence recovered slightly.

The outlook for the ICT and arms industries is excellent. Trump's scattergun policy is accelerating cooperation between countries. Vietnam, India, Indonesia, the Philippines, Poland and large parts of South America are developing steadily. The added value of this may be greater globally than the tariff damage. This partly explains why the market reacted calmly to Moody's credit rating downgrade.

In short, the picture for the near future is foggy. Below is a step-by-step plan that can help supplement the usual scenario methodology.

Step 1: Consider the duration of the tariff impact

Starting a war is easier than ending one, which is why the consequences of the trade war are likely to continue for at least two years. Low oil prices will offset some of the negative effects, which is likely to prolong Trump's battle. A sharp rise, on the other hand, will force politicians to quickly consider other measures, not only in the United States but worldwide.

Step 2: Identify the weakest link, determine the impact and monitor it

There are a number of laws governing the financial markets, one of which is that in a downturn, it is usually the weakest link that is tested. Below, I have outlined the three most decisive regions.

The United States

Sharply rising interest payments by the government and a falling dollar are often cited as external vulnerabilities, with the hope that this will prompt the American government to make different policy choices.

My assessment is that it will be more of an internal development that changes course. More than half of American consumers have less than £2,000 in savings.

In poorer areas that used to be manufacturing hubs, there is a lot of support for Trump's MAGA policy, but this support could easily evaporate if there are setbacks such as higher inflation, waves of layoffs or empty store shelves. It would be wise to monitor indicators that measure public support, such as those compiled by Gallup.

China

Various analysts argue that the blunt tariff policy is strengthening “The Middle Kingdom”, partly because it is accelerating ties with many countries. Exports to the US can therefore be shifted, limiting the damage. However, I have been to China five times in the past 12 months and I estimate that deflation and social unrest will make the country vulnerable in the shorter term.

Xi's policies since 2018 and the ongoing real estate crisis are causing residents to be cautious in both their expressions and their spending. The country is experiencing overproduction, cautious domestic consumption and reduced exports. Many companies and small businesses are suffering losses and trying to survive by cutting prices in the hope of better times ahead. The falling interest rates in China and the recent 35% price reduction on some models by car manufacturer BYD are telling signs. These factors could encourage less rational CCP policies, which is causing concern in the markets. Clingendael and Enodo Economics, for example, offer useful information on this subject.

Europe

Our continent is vulnerable in terms of energy supply (including LNG imports) and we will continue to rely on America for military support in the coming years. The mood among German companies in particular is very gloomy. In addition to increased import tariffs on cars, aluminium and steel, high energy costs and competition from China are also playing a role.

Trump's team looks down on the European welfare state, with its high taxes, lack of political decisiveness, restrictive regulations and problems with immigrants. The recent French report “L'influence de la mouvance des Frères musulmans” on the influence of the radical Muslim Brotherhood in education, associations and social media contributes to this.

As the most vulnerable region, there is a real chance that Europe will be hit hard if Trump's popularity declines. Higher energy costs than elsewhere, combined with little political consensus and a reluctance to give up acquired rights, mean that Europe is paying a heavy price in the form of unemployment and rising debt. The oil price and European interest rates on the capital market appear to be the most decisive indicators for reassessing the risk profile of investments.

Step 3: Watch out for specific signals and ask for an explanation

Chaos theory offers a useful tool in times of uncertainty: if a price or series of figures moves in a straight line – more than usual – tension builds up. I explained this earlier (“Better risk management through the application of chaos theory”, FI magazine 4/2014, pages 84-86). At the end of 2021, for example, European interest rates rose in a straight line for almost 50 days. In such cases, it is advisable to ask for further clarification. If there is no suitable explanation, this indicates increasing instability and “increased vigilance” is advisable. An advantage of this approach is that it also applies to seemingly less important parameters, which greatly expands the universe of parameters to be monitored.

Finally

The seeds of the downfall of every great empire are embedded in the fruits of its success. It was American companies that benefited for thirty years from production in low-wage countries such as China, prompting Nobel Prize winner Milton Friedman to say in 2005: “There is no such thing as an American job.” Trump's policy is partly based on nostalgia, characteristic of rich and powerful countries that are losing their competitive edge in certain areas. Brexit is a similar expression of nostalgia.

The fact that Trump's policy is based more on commercial logic than diplomacy makes it polarising, but also recognisable. The Netherlands also had a merchant-driven government during the Golden Age. When the geopolitical environment becomes more volatile, it requires an adjustment of the usual methods of risk management. By monitoring the behaviour of many parameters, relevant signals that take emotions and less obvious changes into account can be picked up sooner.