The Real Risk to the Global Economy
One might assume that the brewing crises on the Korean Peninsula and in the Middle East pose a serious threat to the current global economic expansion. But political crises often induce only brief market corrections, whereas gradual shifts in international global institutions can be far more consequential for investor behavior.
WASHINGTON, DC – One of the great mysteries of today’s global markets is their irrepressible enthusiasm, even as the world around them appears on the verge of chaos or collapse. And yet, investors may be more rational than they appear when it comes to pricing in political risks. If investing is foremost about discounting future cash flows, it’s important to focus precisely on what will and will not affect those calculations. The potential crises that may be most dramatic or violent are, ironically, the ones that the market has the easiest time looking through.
Far more dangerous are gradual shifts in international global institutions that upend expectations about how key players will behave. Such shifts may emerge only slowly, but they can fundamentally change the calculus for pricing in risks and potential returns.
Today’s market is easy to explain in terms of fundamental factors: earnings are growing, inflation has been kept at bay, and the global economy appears to be experiencing a broad, synchronized expansion. In October, the International Monetary Fund updated its global outlook to predict that only a handful of small countries will suffer a recession next year. And while the major central banks are planning, or have already begun, to tighten monetary policy, interest rates will remain low for now.