Since the fall of the Berlin Wall in 1989 and the collapse of the Soviet Union in 1991, the U.S. has been the undisputed global superpower. Ideologically, it seemed as if we reached the End of History (i.e. the belief that free-market capitalism and liberal democracies are the culmination in the history of man’s socio-political development) and the beginning of Pax Americana. This led to a decline of geopolitical risk premiums across the world, a period known as the Great Moderation. However, almost three decades later, the U.S. is in relative decline, with the economic balance of power shifting towards the East, and China in particular.
What does this mean?
Financial markets always play out against the background of more structural and longer-term political and cultural developments. The post-war period until 1973 was the period of the Bretton Woods system, with fixed exchange rates and capital controls, coupled with rapid nominal growth and active fiscal policy by governments in the background of a divided world by the Cold War. The problem of stagflation and the collapse of the fixed-currency system by the 1971 “Nixon shock” led to a new paradigm: that of neoliberal policies and an active role of monetary policy by central banks and the global dominance of the U.S. that pushed for globalization and democratization across the world. This system eventually led to the 2008 financial crisis. As a result, the current political (e.g. populism, globalization backlash) and socio-economic developments (e.g. ageing societies, weak productivity growth) could thus usher in a new economic paradigm, driven by the new geopolitical imperatives of the coming era of Great Power Competition.
As China is challenging U.S. hegemony, it will lead to a climate with heightened geopolitical risk. The trade war is just an omen of this, and is part of an upward trend in geopolitical risk since the 2010s, as measured by the Geopolitical Risk Index. Recent empirical studies show that increases in geopolitical risk are significantly correlated with stock market performance, company earnings and resource prices. As a result, the end of the “fourth hegemonic cycle” of U.S. hegemony will result in a more strategic perspective on the economy (e.g. decoupling or relocating strategic value and production chains, increasing soft and hard tariff barriers) and resources (e.g. the U.S. sanctioning the Nord Stream 2 project, countries trying to gain national autarky in strategic resources), that will require a more active stance of financial investors to pick out winners and losersof this era of Great Power Competition.