Entry 5
A weeklong electronic journal.
Feb. 6 2004 4:17 PM

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One of the paintings from India
One of the paintings from India

Today began with small stuff. Some art I picked up for the office in India arrived; we held an internal meeting on revamping one of our publications; I received a smattering of client calls, drafted an op-ed for the Financial Times, and finalized plans for a quick trip to D.C. next Tuesday.

An internal discussion on China was particularly interesting. Global economic well-being relies increasingly on sustainable growth in China, but China is exposed to a great many political risks: a one-party system, the absence of a legal infrastructure, difficult rural reforms, a lack of health and welfare programs, and energy and resource deficiencies. We've read the investment banking research on the topic, and it's banal—everyone presumes prospects for instability don't occur until "later" (after the time frame of the given research has concluded). We're developing a study to address when and how the major risks hit.

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There were a few meetings, too—an international lineup on a rainy Friday. First, closest to home, my friend Jon Becker, dean at Bard College (surprisingly casual in jeans and a sweater), looking for suggestions for an upcoming conference on the future of Europe and Eurasia he's coordinating in Budapest. Phillip Landau, an Israeli economist, in town to talk about the shifting domestic balance in Israel (and what he considers a rapidly destabilizing political base). All pretty standard stuff for a day in the office.

But there are many things that can stop a day from being average. Normalcy presumes that global news is percolating without boiling over. Pick a crisis, any crisis—a summit meeting, an election, an unexpected piece of legislation, or armed conflict—and whoever works on the area where the situation occurred has just had their daily routine upset.

The war on Iraq did that for a solid month. Eurasia Group had an internal task force covering the war, updating each other daily, creating strategy and analysis. But Iraq was unusual in that by the time the war hit, everyone was expecting it. We had time to prepare for what was likely to happen, and so did the markets. The war was, as they say, "priced in," so by the time the war actually started, the markets rallied. In contrast to the international public outcry against the invasion, the fear for the investment community was uncertainty, not the war itself.

That's unusual. Today, the unexpected was a bit more sudden.

Alex Brideau (glasses) and Alec Alenstein, talking Russia
Alex Brideau (glasses) and Alec Alenstein, talking Russia

A particularly gruesome Moscow subway bombing, on top of the deterioration of the business environment we've been watching all week, kept our Russia analysts in a state of intense activity. It spills over into my day as well; I find myself engaged in a back-and-forth with Japanese officials in charge of Tokyo's policy on Russia. Japan's strategic realignment is a long, gradual process and is proceeding smoothly, but Secretary of State Powell's suddenly harsh meeting in Moscow last week has them spooked. It should; the strongest days of U.S.-Russia partnership ended a couple of months ago, but the Powell visit was the first time the new tensions got aired publicly. This week's news isn't helping matters. I'll be in Tokyo at the end of the month, and the topic will be high on the agenda.

Then there is a rather sudden meeting with a friend in the Russian diplomatic corps—more discussion of problems in the U.S.-Russia relationship. That's been the biggest trend this week, gaining momentum since the Monday morning meeting. I sense that the investors see the problem, and we might have hit the inflection point on the Russian bull market—from here on out, it looks downhill. If so, Russia will dominate financial news for the coming month.

It's important to remember that the links between politics and economics can create a vicious circle. Thus it is crucial for a political scientist to have experience in both the private and public sectors. Some political actions may not directly affect a country's stability, but they can shift market sentiment, causing severe economic dislocations … which in turn can create political instability.

The trick is not only to get the politics right, but also to have a sense of how the markets will react. Last year, for example, our Latin-American team was convinced that Lula da Silva would win Brazil's elections and that he would end up taking a moderate position, which would have been favorable for the markets. This was a controversial call indeed. But right up until the elections, the markets considered Lula a dangerous populist and a disaster for the Brazilian economy. Had the markets not changed their view of him (which they did, at the last minute—a growing group of analysts effectively having made Lula's case) investors would have fled from Brazil, and Lula would have become the destabilizing force that everyone had feared.

More dangerously, governments can make policy miscalculations by not factoring in market reaction. North Korea is a good example. Many in the Bush administration believe that a North Korean nuclear test would have positive strategic implications for resolving what has been a diplomatic impasse—it will show the intransigence of the North Korean position and lead other countries (most notably the South Koreans and the Chinese) to join the United States in stepping up the pressure and isolating Pyongyang. Which makes sense, except that a nuclear test has immediate market implications: Investors will bolt from South Korea and, to a lesser extent, Asian markets in general. This would in turn cause South Korea and China to desire an end to the crisis—and motivate them to negotiate with North Korea, not to isolate it.

No matter how I look at it, politics and the markets seem inextricable.

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