The two categories of Geopolitical risk are Threats, such as China’s threats to attack Taiwan, and Actual Events like 9/11.
The 2022 threat of Russia taking over Ukraine created only nervous concern in the neighborhood whereas the actual invasion galvanized widespread condemnation of Russia’s invasion as a vicious, unwarranted geopolitical event.
In response, the rouble almost instantly lost more than 60% of its value and Volodymyr Zelenskyy became a Churchillian war hero. But geopolitical events are not always so dramatic.
Of a quieter nature was Brexit. Prior to Britain’s vote to leave the EU, many investors reduced their UK assets. If Scotland now votes to leave the UK, there may be further weakness in UK stocks and the pound. Somewhat balancing this trend, there is a sudden interest in the UK to rejoin the EU. This has helped stabilize the pound. Or maybe it only gives false hopes to holders of UK assets?
Many of the geopolitical events impacting Canadian investors arise from Canadian resource companies’ exposures to far-away places like Outer Mongolia, the Congo and southeast Asia. Too often it has happened that once the discovery becomes profitable, the local autocrat would quietly come up with reasons to change the terms of their financial relationship. Large international companies can ignore such larcenist attempts, but the small fry have little leverage if they want to remain independent.
Bulling tactics like these can also lead to war. The Boston Tea Party – the dumping of British tea in Boston Harbor in protest of a British tax on tea– was a prelude to the U.S. Revolutionary War. The Opium wars between China and England were fought over Britain’s insistence on trade access to China while China just wanted to be left alone. Being an island nation, England was thought to have believed it was immune to reprisals.
Of course, the two world wars are the leading twentieth century geopolitical events. Both started off slowly as local conflicts, only to realize their worldwide potential within a year. WW II did much to shift the world economic center to North America. So much rapid change created an underlying mood of uncertainty, but it is uncertainty that so often creates the best investment opportunities.
That is not to say war is necessary to create investment opportunities. The Suez Canal is a great case in point.
On July 26, 1956, the president of Egypt, Gamal Abdel Nasser, announced he had nationalized the Suez Canal company. Prior to that moment, the British and French jointly controlled the canal they had operated since its construction in 1869.
Nasser said he wanted the income from the canal to build the Aswan Dam. He also said he was tired of the French and English perpetuating their political and cultural influence in an Arab region. In short, he thought his people no longer need accept being colonials. Nasser said he would compensate the British and French for their stock, hoping they would go away. The British made it clear they would fight to retain ownership. The Israelis offered to join them because they thought Nasser, an Arab leader, was a threat to them.
War was imminent. There were 18 nations dependent on being able to send and receive goods through the canal. Months later, thanks mainly to the United Nations and U.S. President Eisenhower, an agreement was reached. An Egyptian corporation would own and operate the Suez Canal much as it had been run. Threats extinguished. Crisis averted. For the overly cautious, another investment opportunity missed.
Next to the Ukraine war, the most potent geopolitical risk for 2023 is the threat from China to take Taiwan by force. China claims the island of Taiwan is Chinese territory. Whether this is true is irrelevant. Clearly China has the military power to take what it wants in that part of the world. It has several reasons to want Taiwan, but the question is, will it?
What makes Taiwan financially tempting is the Taiwan Semiconductor Manufacturing Company (TSM), a $435 billion dollar enterprise that is the world’s leading member of the chip industry. It is the leader because it can design and produce the most sophisticated chips required by all the leading-edge industries.
Many astute investors think it inevitable that China will takeover Taiwan. This is despite the fact Taiwan has a large well-trained army, the best military equipment the U.S. can provide and is separated from China by 150 miles of water.
On the other hand, there are those in the chip industry who think the island grab doubtful. They say the half dozen sophisticated chip manufacturers compete vigorously, but they have a special relationship with one another. Taking over TSM by force without the willing compliance of the Taiwanese and key TSM personnel would isolate China as an international chip producer. As a result, the takeover of TSM by force would likely be counter productive.
Quantitively-driven investors would prefer not to deal with geopolitics. However, expecting a future without geopolitical risk is just wishful thinking and for the thoughtful investor geopolitics can create golden opportunities. It’s for this reason that, despite their waning popularity, we hope Canadian universities will continue to teach history and political science, as well as mathematics and engineering.
The views as articulated in this article are those of Briar Foster alone and do not necessarily reflect the opinion of Foster & Associates.
