Heightened Political and Geopolitical Risks

Summary

In a revealing discussion with David Westin on Wall Street Week, Neil Ferguson of the Hoover Institution delves into the escalating political and geopolitical risks facing the US, offering a historical perspective to contextualize current tensions. Drawing parallels to past eras, notably the precariousness of 1974, Ferguson posits we're in the early stages of a 'Cold War II,' initiated by Xi Jinping's ascent. Highlighting the market's inadequacy in discounting political risks, he explores how historical insights could guide present-day investment decisions. Ferguson underscores the potential global economic upheaval a conflict over Taiwan could unleash, especially on AI development and semiconductor production, likening it to a modern-day Cuban Missile Crisis but with far greater economic stakes.

Takeaways

• 💭 Neil Ferguson, a senior fellow at the Hoover Institution, discussed the rise in political and geopolitical risks in the U.S. with David Westin on Wall Street Week.
• 📊 Ferguson suggests taking a long-term perspective to understand current geopolitical dynamics, comparing today's relative peace to the more tumultuous periods of the 1970s and the 1990s.
• 🔮 He notes that the period following the Soviet Union's collapse was mistakenly perceived as low-risk, leading to an underestimation of emerging geopolitical tensions.
• 📓 Ferguson is writing the second volume of his biography on Henry Kissinger, providing him insight into the comparison of current times with the past.
• 🛡️ He believes that the current geopolitical tension, dubbed Cold War Two, began with Xi Jinping's rise to power in China, signaling a new era of global rivalry.
• 📈 Markets often fail to adequately anticipate political and geopolitical risks, according to Ferguson, highlighting a gap in predictive capabilities.
• 📊 Historical analysis reveals that markets do attempt to adjust for domestic political risks, especially noticeable during election years in the U.S.
• 📰 The conversation emphasizes the difficulty in responding to geopolitical risks as an investor, especially with potential conflicts that could disrupt global economies.
• 🛠️ The economic implications of a crisis in Taiwan, particularly concerning semiconductor manufacturing, could have profound global economic impacts, far surpassing historical crises like the Cuban Missile Crisis.
• 🔥 A conflict over Taiwan would likely lead to significant disruptions in the semiconductor industry, illustrating the high stakes of geopolitical tensions on global trade and economy.

Q & A

What long-term perspective does Neil Ferguson suggest for understanding current geopolitical risks?

Neil Ferguson suggests taking a longer-term perspective, comparing the relatively peaceful 1990s post-Soviet Union collapse with the dangerous period of 1974, to understand the current geopolitical risks.

According to Neil Ferguson, how does the present geopolitical situation compare to the Cold War era?

Ferguson notes that the recent past was an interwar period between two Cold Wars, suggesting that we are currently in the early stages of a 'Cold War two' initiated by Xi Jinping's rise to power in China.

What does Neil Ferguson imply about the future of global peace based on current trends?

Ferguson implies that global peace is not expected to increase by 2025, indicating that geopolitical tensions, especially with the initiation of what he terms 'Cold War two', will likely continue or escalate.

How does Neil Ferguson view the market's ability to discount political and geopolitical risks?

Ferguson believes that markets do not do a particularly good job of discounting political and geopolitical risks, indicating a gap in the financial market's ability to anticipate such uncertainties.

What example does Ferguson give to illustrate how markets adjust for domestic political risk?

Ferguson points out that markets tend to make some allowance for policy uncertainty during election years, particularly noting the significant difference between candidates like Donald Trump and Joe Biden as an example.

Why is it challenging for investors to address geopolitical risks, according to Ferguson?

Ferguson suggests that while identifying geopolitical risks is crucial, the real challenge for investors lies in determining how to respond to these risks, especially when they could profoundly impact the global economy and financial markets.

What specific risk does Ferguson highlight regarding a potential conflict over Taiwan?

Ferguson highlights the risk of disruption in the global semiconductor supply chain, specifically pointing out the potential destruction of TSMC foundries in Taiwan, which would have significant economic implications.

How does Ferguson compare the economic implications of a Taiwan Semiconductor crisis to the Cuban Missile Crisis?

Ferguson compares the two crises by emphasizing the much greater economic significance of high-end semiconductors today, as opposed to Cuba's exports in 1962, suggesting a Taiwan crisis would pose both a huge geopolitical and economic risk.

What immediate effect does Ferguson predict in the event of a Taiwan crisis?

Ferguson predicts that even before any military action, news of a Taiwan crisis would cause major economic disruption, highlighting the critical importance of Taiwan in the global semiconductor industry.

What does Ferguson's comparison of geopolitical periods suggest about our current era?

Ferguson's comparison suggests that while the world may seem tumultuous now, it's important to consider historical periods of greater danger, such as 1974, to understand that the nature and scale of geopolitical risks can vary significantly over time.

Outlines

00:00

🌐 Analyzing Political and Geopolitical Risks

Neil Ferguson, a senior fellow at the Hoover Institution, discussed with David Westin on Wall Street Week the evolution of political and geopolitical risks, emphasizing the importance of a long-term perspective to fully grasp the current situation. By looking back to the relative peace of the 1990s and contrasting it with the tumultuous 1970s, Ferguson illustrates the cyclical nature of international relations and argues that we are now in the early stages of a new Cold War, primarily driven by the rise of China under Xi Jinping. He asserts that this period is likely to escalate rather than abate in the near future. Furthermore, Ferguson touches on the market's inadequate handling of political and geopolitical risks, suggesting that while there is some adjustment for domestic political uncertainty, especially during election years in the U.S., there is a significant underestimation of geopolitical risks. He highlights the potential global economic fallout from a hypothetical conflict over Taiwan, particularly focusing on the semiconductor industry's vulnerability, drawing parallels to the Cuban Missile Crisis but with far greater economic stakes due to the importance of high-end semiconductors.

Keywords

💡Geopolitical Risk

Geopolitical risk refers to the potential impact on global or regional stability and economic performance resulting from political actions, conflicts, or upheavals at the geopolitical level. In the video, this term is used to discuss the increasing political and geopolitical tensions, particularly between the US and China, and their potential impact on global markets and the economy. The discussion suggests that understanding and anticipating geopolitical risk is crucial for investors and policymakers, especially in the context of rising tensions and the potential for significant disruptions, such as a conflict over Taiwan.

💡Cold War

The Cold War is mentioned as a historical period of geopolitical tension between the Soviet Union and the United States, characterized by political and military rivalry without direct armed conflict between the two superpowers. The speaker references this period to draw parallels with the current geopolitical climate, suggesting we are in a 'second Cold War', this time with China. This comparison serves to highlight the cyclical nature of international relations and the importance of historical context in understanding current geopolitical risks.

💡Interwar Period

The interwar period is traditionally understood as the time between the first and second World Wars, but in the video, it's used metaphorically to describe the relatively peaceful years following the end of the Cold War until the rise of new geopolitical tensions with China. This concept is important to the speaker's argument that the recent past's relative peace may have led to complacency among markets and policymakers about the potential for new conflicts, underlining the need for a broader historical perspective.

💡Taiwan Semiconductor Crisis

The Taiwan Semiconductor Crisis is a hypothetical scenario described in the video, referring to the potential economic and geopolitical fallout from a military conflict involving Taiwan, particularly focusing on the semiconductor manufacturing industry. Taiwan Semiconductor Manufacturing Company (TSMC) plays a central role in the global supply of semiconductors. A conflict that disrupts TSMC's operations would have significant global economic implications, far surpassing historical crises like the Cuban Missile Crisis, due to the critical importance of semiconductors in modern technology.

💡Investment Boom

The term 'investment boom' in the video specifically refers to the surge in investments in artificial intelligence (AI) and related technologies following significant advancements, such as the introduction of GPT-3 by OpenAI. This concept illustrates how technological innovations can drive economic trends and investment patterns, and also highlights the vulnerability of these investments to geopolitical risks, such as the aforementioned Taiwan Semiconductor Crisis.

💡Election Year

Election year refers to the period during which political campaigns and elections take place, leading to heightened uncertainty about future policy directions. In the video, it's noted that markets attempt to adjust for domestic political risk during election years, as policy uncertainty can affect investment decisions. The discussion underscores the significance of electoral politics in shaping economic expectations and the challenges of navigating this uncertainty as an investor.

💡Policy Uncertainty

Policy uncertainty pertains to the lack of clarity or predictability regarding government policies, which can affect economic and investment decisions. The video mentions that investors make allowances for policy uncertainty during election years, indicating that the outcome of elections and the policies of the incoming administration can have substantial implications for markets. This concept is essential for understanding how political changes can influence economic stability and investment strategies.

💡Henry Kissinger

Henry Kissinger, mentioned in the video as the subject of a biography the speaker is writing, was a key figure in American foreign policy during the Cold War. His inclusion in the discussion serves to provide historical context for the conversation about geopolitical risk and strategy. Kissinger's policies and approach to international relations, particularly detente and realpolitik, are used as a point of reference for understanding current geopolitical dynamics and the importance of strategic thinking in navigating international conflicts.

💡Xi Jinping

Xi Jinping is referenced in the video as the leader whose ascent to power in China marks the beginning of what the speaker characterizes as the 'second Cold War'. This mention underscores the pivotal role of leadership changes in shaping geopolitical landscapes and tensions. Xi's policies and approach to governance and foreign relations are seen as central to the changing dynamics of global politics and the emerging geopolitical risk involving China.

💡Global Economy

The global economy refers to the interconnected economic activities and systems that span across the world. In the video, concerns about geopolitical tensions, particularly a conflict over Taiwan, potentially shaking the foundations of the global economy are discussed. This highlights the intricate link between geopolitical stability and economic prosperity, emphasizing the potential for significant geopolitical events to disrupt global trade, investment, and growth.

Highlights

Neil Ferguson discusses the rising political and geopolitical risk in the US with David Westin, highlighting the importance of a long-term perspective.

Ferguson compares the current geopolitical climate to the relative peace of the 1990s, following the Soviet Union's collapse.

He reflects on 1974 as a more dangerous time than now, citing his work on Henry Kissinger's biography to provide historical context.

The conversation turns to the notion of an 'interwar period' between two cold wars, suggesting the current era as the beginning of a second cold war initiated by Xi Jinping's rise to power in China.

Ferguson predicts that the world will not become more peaceful in 2025 and discusses the challenges markets face in discounting political and geopolitical risks.

The discussion explores how historical market reactions to political events can inform current investment decisions.

Ferguson points out that markets do adjust for domestic political risk, especially during election years, based on policy uncertainty.

He refutes the idea that markets inherently fail at predicting outcomes, instead showing how election years demonstrate cautious investor behavior.

The challenge of dealing with geopolitical risks as an investor is acknowledged, particularly the potential global economic impact of a conflict with China.

Ferguson highlights the AI investment boom driven by companies like OpenAI and NVIDIA, and the critical role of TSMC, the leading semiconductor manufacturer.

The potential disruption to the global semiconductor supply chain in the event of a conflict over Taiwan is discussed as a significant economic and geopolitical risk.

The possibility of TSMC foundries being destroyed in a Taiwan conflict is presented as a scenario with far-reaching economic implications.

Ferguson compares the potential Taiwan Semiconductor crisis to the Cuban Missile Crisis, emphasizing the greater economic impact due to the importance of semiconductors.

The conversation concludes with a discussion on the immediate economic disruptions that would precede any military conflict over Taiwan.

Ferguson uses the example of Cuban cigars to illustrate the comparatively minor economic impact of the Cuban Missile Crisis relative to a potential crisis over Taiwan.

Transcripts

Neil Ferguson, Hoover Institution senior fellow, spoke with Wall Street Week host

David Westin yesterday about rising political and geopolitical risk in the

US. I think you have to take a slightly

longer term perspective in order to understand where we are.

If you go back maybe to the 1990s, yeah, that period seemed pretty low risk.

The Soviet Union had collapsed and apart from trouble in the Balkans with the

breakup of Yugoslavia and some other trouble spots like Somalia, the world,

by the standards of the rest of the 20th century, was pretty peaceful.

But if you go back 50 years, imagine we're back in 1974.

That was a much more dangerous time than we're living through now.

And I speak with some insight as I'm in the midst of writing about that period

as I write the second volume of my biography of Henry Kissinger.

So we have a tendency to judge the present by comparison with the recent

past. But the recent past was an interwar

period, the period between two cold wars, Cold War.

One ended with the Soviet collapse, and we didn't really notice Cold War too

beginning. But I think it really began when Xi

Jinping came to power in China. And now Cold War two is in its, I guess,

second inning. It has some way still to go.

And I don't expect the world to get more peaceful in 2025.

It is a commonplace that the markets do not do a particularly good job of

discounting, as it were, either political or geopolitical risk.

Can we learn from history some of the things you suggested, even going back

further? Can we learn how markets and investors

reacted to really unthinkable developments as they happened and use

that to inform our investment decisions today?

Well, I think we know that markets try to adjust for domestic political risk.

We know this because there's been some great work done in recent years on the

way that in an election year, investors have a tendency to make some

allowance for policy uncertainty. And the bigger the difference between

the candidates in the United States, the more uncertainty.

And we've certainly got a pretty big difference this year, but it's the same

difference that we had back in 2020 between Donald Trump and Joe Biden.

So I think it's not true to say that markets are bad.

I think we can see in the data that that by and large election years see a

certain amount of holding back as we wait to see just how the policy

uncertainty will be resolved. And I think the closer we get to

November the fifth, the more obvious that's going to become.

But I think you're right, David, that when it comes to geopolitical risk, it's

actually much harder once you've spotted the issue as one thing to spot the

issue, which is terribly important. What do you do about it as an investor?

Because as you suggest, if there really were a conflict of some sort with China,

it could shake, I think, the very foundations of the global economy and

global financial markets. Without a doubt.

I mean, let's remember that the current A.I.

investment boom, the kind of mania that we have seen since Openai revealed GPT

three assumes that TSMC, the most

sophisticated semiconductor manufacturer will continue to be able to make those

things for Nvidia and Nvidia will be able to ship them to the people doing

A.I.. Now, if there were a war over Taiwan,

that would immediately be disrupted in a case of invasion.

There is a very high probability that the TSMC foundries would be destroyed

either by TSMC or by the United States. It's inconceivable that in wartime TSMC

would be able to run smoothly. Nor is it likely that China, if it

successfully took over Taiwan, would be able to run TSMC seamlessly.

So I think the economic implications of what would be the the Taiwan

Semiconductor crisis would be much, much larger than the economic implications of

the Cuban missile Crisis in 1962. Now, that was a very dangerous moment in

Cold War one, because it was the closest we came to World War Three.

But what does Cuba export? That's right, David.

Cigars. Now, some people like cigars, but

economically they're much less important than high end semiconductors are today.

So this would be a kind of Cuban missile crisis with huge geopolitical risk, but

also with huge economic risk. Even before a shot was fired, the news

that there was a Taiwan crisis would cause, I think, major economic

disruption.