The end of the American empire – and what it means for markets

published 9 October 2014

14-10-09-US-flag — US economic power is declining

Wondering why everything seems to be going wrong at once?

After a period in which most of the world seemed to be more or less at peace, everyone seems to want to go to war.

The trouble with Russia and Ukraine, and the tensions between China and Japan (and everyone else in the South China seas), are just the tip of the iceberg.

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The good news is that there's a perfectly simple explanation for all this chaos.

The bad news is that investors so far seem to have no idea of what's about to hit them.

History isn't done with us yet

Russia and Ukraine are far from the only political hotspots in the world. There's the rise of nationalist movements in Europe (from Scotland to Catalonia), and the disturbing power struggle around the disappearance of Kim Jong Un in North Korea.

There's the Arab Spring, the Syrian civil war, and of course, the rise of extremist Islamic militants, a symptom of chaos that has now moved into Turkey.

Chuck Ebola into the mix and it all feels pretty uncomfortable.

Twenty-five years ago, Francis Fukuyama told us that history had ended. Liberal democracy had won the war of the regimes, and long-term peace would surely follow. That clearly hasn't worked out: in an interview with The Sunday Times a few weeks ago, one of the world's best-known optimists noted that "things are looking very bad".

However, there is a perfectly simple explanation for the chaos around you. It is, say the analysts at Deutsche Bank in a recent report, all about the end of an empire specifically the US empire.

"When we look at the broad timeline of world history, to our eye the main contender as a consistent major driver of significant structural change in global levels of geopolitical tension is the rise and fall of the world's leading power."

When a single power is more or less in control, we get stability. When it begins to fall and we see the rise of equal or competing powers, we get "structurally high geopolitical instability", as everyone struggles for influence and land.

For evidence, you can look as far back as the death of Alexander the Great in 323 BC. Under his dominance, all had been calm. But after his death, the on and off' tensions caused by competing powers only ended with the rise of Rome and the Pax Romana.

Or you can look to the British Empire from 1815 to 1914 when the UK's global power waned, so did peace.

The next great power became the US, which became truly globally dominant after the end of the Cold War, something says Deutsche Bank, that gave us a few good decades of falling geopolitical tension.

Unfortunately, as Fukuyama can see, that might be over. US economic power is declining, while China's is rising (note how the US has had no strategic response to China's constant claims over islands other countries believe to be theirs). Other groups want theirs to rise too.

We will write more on this (and we've looked at the problems in Russiaand Asiarecently), but the key point to note is that you can argue that all the seemingly separate crises unfolding around us are in fact fully connected by the end of the global dominance of the US, and the rise of competing powers keen to fill the gaps. It is a "rare political event", if not a good one.

War is not the only threat globalisation doesn't always go one way

This matters for all the obvious reasons. But it should also matter for markets.

As global tensions have risen, so the risk premium' should also have risen, pushing down the price of stocks if it is more likely that unpleasant surprises might hit the profits of the companies you are investing in, you will pay less for shares in those firms.

You might think of those unpleasant surprises just in terms of actual war and violence. But the globalised nature of the economy makes it rather more complicated that than.

The FT's Gillian Tett gave one example earlier this week. Most of the world's bank transactions pass through what is effectively a banking utility the Belgium-based Society for Worldwide Interbank Financial Telecommunications (Swift).

It's a good system efficient, global and growing (it recently notched up a record number of daily transactions). But there's a problem with it. The US and the European Parliament want Russian banks expelled from the system "in protest at Russia's excursions into the Ukraine."

Swift says no. But nonetheless Russian officials are warning that they will build an alternative, and have held talks with China on the matter. The result directly caused by geopolitical tension could be two networks. That would mean less efficient global payments all round, something that would affect everyone.

It might seem minor and a long way off but it is a nice reminder that globalisation doesn't always only go one way.

Why are markets ignoring this?

Still, so far the markets don't seem as bothered as you might think they should be. Stocks have wobbled but the US market in particular remains just as overpriced as ever, and is up 8% on the year so far.

That might simply be because not everyone is as clever as the analysts at Deutsche they see a lot of isolated incidents to worry about a bit, and a few areas that are no longer on their city breaks list, but no connecting theme that makes the disruption long-term and nasty.

They also don't see the rising oil price that often accompanies political problems. And there may also be something of a time lag. The period since the fall of the Berlin Wall has been exceptionally peaceful it's hard to accept that it might not stay that way.

However, the lack of a real risk premium is probably also a result of the world's loose monetary policy. Investors have long been using this as an excuse to ignore absolutely everything that goes wrong everywhere if every problem is met with quantitative easing (QE), there are no problems. Whatever happens and wherever it happens, markets will keep rising.

So, you might wonder what happens as the US ends its current programme of QE and global monetary policy tightens as a result. John Stepek looks at this in detail in this week's issue of the magazine (available online later and in print tomorrow if you're not already a subscriber, subscribe to MoneyWeek magazine).

But if you are looking for investments run by managers who recognise that the world isn't as perfect as it was, two investment trusts might suit Personal Assets Trust (LSE: PNL) or BH Macro (LSE: BHMG). Both have abysmal short-term records but, rather like gold, will come into their own when everyone else comes to their senses.

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.