Globalization has drawn geopolitical risk increasingly into the spotlight, connecting international politics with global markets. While political risk can refer to domestic policymaking, national corporate laws, and investment regulations, geopolitical risk largely affects markets and assets across borders. Symptoms of hostile tensions between two states, such as missile launches, drone attacks, or airstrikes, can send market prices soaring and create a panic. Following the killing of Major General Qasem Soleimani in a targeted US drone strike in Baghdad on January 3, 2020, social media users and tabloids spoke only half-jokingly of a forthcoming Third World War. Another event that caused a significant market panic was the drone attack on Saudi Arabia’s state-owned Aramco oil facilities in September 2019, which resulted in a dramatic single-day increase in oil prices. In that instance, however, prices recovered relatively rapidly, leaving businesses and risk managers uncertain about the true magnitude of the impact that geopolitical incidents have on markets.
In order to understand the relevance of geopolitical risk, we must understand the nature of geopolitical events and differentiate between long-term and short-term risks. Geopolitical events like a surprise drone attack are difficult to anticipate and can have a much higher or lower impact than expected, which is why making precise predictions is challenging. Markets can be quick to overreact before they restabilize, as pinning down the long-term implications immediately after these events can prove difficult. As soon as political developments become more predictable, however, markets adjust and become less volatile. For instance, US President Donald Trump’s political statements on his Twitter account may cause political uncertainty, yet their frequency has taught markets to react cautiously to unexpected announcements.
It is important to note that sudden explosions of geopolitical tension sometimes result in ongoing or even escalating mutual retaliation. When this occurs, businesses and markets can be put under stress for more extended stretches of time. Trade wars are prime examples of long-lasting geopolitical bouts. While the effects of trade wars are largely financial and economic, their root causes are commonly political, with international power plays or historical conflicts acting as catalysts for trade wars. As the US-China trade war and the Japan-South Korea trade dispute have demonstrated, international trade can be powerful leverage against one’s political opponent.
While bursts of geopolitical conflict, such as drone strikes, may create more immediate uncertainty, it is important to examine the potential effects of a medium to long-term escalation. A country’s foreign policy objectives, international alliances, and the personal motivations of its political leaders, among other factors, can indicate what is at stake and how businesses assess the relevance of various risks. Such factors vary from case to case, making geopolitical risk volatile and ever-progressing. Geopolitical risk levels can shift as new governments are formed, creating initial uncertainties and new opportunities alike. Continuously monitoring international relations and profiling heads of state, government administrations, and critical stakeholders are therefore vital.
Returning to the question of how much geopolitics matters we can conclude that the impact of geopolitical risk may be difficult to grasp. We cannot necessarily foresee sudden airstrikes, but we may acquire a better understanding of risk levels through a holistic approach that reflects on past events and evaluates what is at stake for political leaders in terms of personal, political, economic, and military affairs.
