A Geopolitical Outlook For 2023

Tom Donilon, Chairman of the BlackRock Investment Institute and former National Security Advisor to President Barack Obama returns to this special post-Davos edition of The Bid to provide his take on the geopolitical issues that are shaping the global investment landscape in 2023.

Transcript:

Catherine: Welcome to The Bid where we break down what’s happening in the markets and explore the forces changing the economy and finance. I’m your host, Catherine Kress. Today, we’ll be discussing some of the geopolitical issues that are shaping the global investment landscape in 2023.

From conflict and war to energy crisis and technology competition, we’ll be exploring the ways in which political factors are impacting the financial markets and what it means for investors. I’m pleased to welcome today Tom Donilon, Chairman of the BlackRock Investment Institute and former National Security Advisor to President Barack Obama. Tom, welcome.

Tom: Thank you, Catherine. It’s nice to be here today.

Catherine: Tom, you were at the World Economic Forum’s annual meeting in Davos, where you met with public and private sector leaders from around the world. What were your main takeaways from the week?

Tom: Yes, Catherine, this was the first full meeting at Davos in three years. There was a smaller meeting this past spring, but this was the first full-on session with the full attendance at Davos since January of 2020.

And what struck me on reflection is just how much the world has changed. It’s been a tumultuous time the last three years – certainly as tumultuous a period that we’ve seen since the end of the Cold War – some would argue even a longer period than that. And this period has been characterized by a series of repeated shocks to the system and major crises.

The most prominent of which obviously are Covid and the Russian invasion of Ukraine – which is important to note is not just a regional security event, but has been an event with global impact and I think durable impact, which we can discuss. A new order has emerged over the last few years and it’s accelerated a lot of trends that were already in train, but it’s characterized by a number of things.

One is fragmentation – increased fragmentation between and among nations.

Second, a dramatically reduced amount of cooperation among and between the important powers. If you think about the Covid crisis, the United States and China, for example, were not able to organize a global response. You would think a health crisis would be the basis on which you could have global cooperation among the major powers, and we weren’t able to pull that together around the Covid crisis. Even during the course of the Cold War, the United States and the Soviet Union were able to work together to eradicate smallpox. And we saw that, in reflecting back on the Great Financial Crisis – the last global crisis prior to Covid – you had the G20 assembling in the spring of 2009, with the presidents of the United States, the Russian Federation and China working together to put together a common approach to trying to bring back the world from an economic abyss and to put together an economic plan for the world. That meeting, addressing a prominent global challenge, is really not conceivable today. That’s a huge change. So you do have reduced cooperation.

And the third, I think, flows from the first two, which is the forming up of economic and geopolitical blocs. And with, frankly, geopolitics replacing markets and efficiencies as driving forces in terms of economic relationships and energy relationships.

So a more fractured world is the main major theme that I come away with.

Now, despite that very challenging environment, there were some elements of optimism coming through the Davos meetings.

And I think they were based on three or four things. One is a sense that a recession in the United States and in Europe will be less severe than had been expected. Two, a better-than-expected energy situation, where we haven’t been driven towards the crisis I think people were expecting for a variety of reasons, including European policy, better weather than had been expected, and by the way, importantly, the United States supporting our European allies in terms of energy supplies. The China reopening that was announced coming into Davos and underscored by the presence there of Vice Premier Liu He, and continued Western unity on Russia. So I think those gave a sense, at least, of tactical optimism at this point.

I’ll finish with just a couple of specific things that were prominent in the discussions.

One, obviously Ukraine, which was the backdrop to a lot of the discussions that took place in Davos. And again, as I said, unity. Also, a recognition that there’s really not, at this point, a short-term path that analysts see towards a resolution in Ukraine.

Second on China. Yes, an economic reopening, but still challenges and the Chinese, I think, acknowledge those challenges in terms of opening up and pursuing economic growth as the principal priority.

Energy was front and center, with the recognition during the course of the crises of the last several years of the importance of energy security, supply, and affordability.

The Inflation Reduction Act came up in almost every setting. Some concerns on the European side about whether or not the United States had engaged in practices that give unfair advantage to US companies and investment in the United States. I think that we’ll push past those. I think the major impact of the Inflation Reduction Act will be catalytic and will actually encourage and give momentum to investment in climate and energy technologies.

And last, there was a lot of talk about artificial intelligence, particularly ChatGPT where everybody was moving around with their favorite question and answer that they wanted to demonstrate. So those are some of the impressions I had coming away from the Davos meetings.

Catherine: So Tom, you mentioned that Ukraine really served as the backdrop to a lot of the discussions that you had at the Annual Meeting. We’re coming up on almost a year now of the war in Ukraine. What’s your take on the state of play?

Tom: Following a number of successful counter-offensives by the Ukrainians in the fall, the front lines have largely remained the same.

There’s been some back and forth in some specific battles over the last few weeks, but both sides are essentially in a standoff at this point, going into the winter. The front lines are hundreds of miles long and, in some parts, there are really miles of trenches and almost a feeling of a World War I like warfare, including artillery duels, and again, troops entrenched along defensive lines that they’re continuing to build out. That’s the first impression.

The second is that this war is exceedingly violent. Western officials have said publicly that they think that the Russian totals of killed and wounded is well over 100,000. The Ukrainians don’t put out official statistics, so we’re really not really sure what the statistics are on the Ukrainian side.

Three, this has been and continues to be a humanitarian disaster for Ukraine. Nearly 8 million Ukrainians, Catherine, have been recorded since the Russian invasion last February, according to the United Nations. And the International Organization for Migration estimates an additional 6 million Ukrainians are currently displaced within Ukraine.

You know that adds up, to overall, one third of the Ukrainian population has been forced to leave their homes, since the beginning of the war. I should remark by the way, with respect, to the nearly 8 million Ukrainian refugees which have left the country, that they have been provided for through, quite a program of outreach and support by the Europeans. It’s a notable aspect of the effort.

Next, I think that both sides appear to be preparing additional offensives. Experts believe that the Russians have deployed more than 100,000 mobilized personnel over the past few months to try to stabilize the lines to prepare for an advance.

These are far from Russia’s best fighters, they’re conscripts. In some cases, of course, a lot of the fighting has been done in critical areas by the Wagner Group, which is essentially a mercenary organization that works at the behest and direction of the Russian government.

I think that we can expect, if not before, certainly as we go into the spring, offensives in the war.

Next is that, continued economic and military support from the West is the most critical element I think for Ukraine going forward. President Zelensky has been quite clear about that in his interactions with leaders from around the world. We’ve had in the United States the passage of an additional $45 billion in support, which should provide, a lot of US support going into the first seven or eight months of 2023. There was a meeting in Germany at the Ramstein Air Force Base where substantial additional military support was committed to the Ukrainian cause. My judgment is that although you’ll have debates as you get into next year, both in the United States and Europe, as the support levels. My bet is that the center will hold, and the support will continue.

There’s a long way to go in this conflict is my judgment. Currently I don’t really see a path towards a ceasefire or a peace process or de-escalation. That doesn’t seem to be a viable path at this point.

In all scenarios, I think that there’s a long-term standoff here between the West and Russia, across multiple dimensions, including political, military, diplomatic and ideological. And I also think we’ll see, by the way, an increased interest in the West on pursuing war crimes prosecutions against Russia.

Catherine: Tom, in our analysis at the BlackRock Investment Institute, we’ve found that geopolitics often has the most significant impact on markets and economies when it affects oil and energy prices. And indeed, one of the most significant impacts of the war in Ukraine has actually been on energy. How are you thinking about the energy landscape today from a geopolitical and national security perspective?

Tom: Let me talk about the broad observation, Catherine, which is that the conflict was building on some dynamics before the war, but has engendered, I think with some experts, believed to be the most serious energy crisis since the 1970s. It is really the first global energy crisis, that we’ve faced.

And it’s caused economic and energy relationships to shift along geopolitical lines as we talked about earlier. That geopolitics instead of efficiency and market forces, are driving energy supply and flows and prices – especially true in Europe, obviously, where we see, Europe separating itself from its largest, and most efficient supplier, at a tremendous political and economic cost.

So lots of dynamics here, I think driven by the war. Some observations though as to where the energy markets stand. The first is that energy security and reliability and affordability have come to the floor as issues in the wake of the war. And indeed they are now, for policymakers have to sit alongside the policy goals of decarbonization and climate goals.

Second, as we’ve seen the politicization and weaponization of energy resources. We’ve certainly seen the Russians engage in that cutting off energy supplies to the Europeans.

Third, we’ve seen a permanent diminishment of Russia as a global energy power moving forward, for lots of different reasons. They’ve had increased prices in oil and gas, which have sustained the Russian economy since the beginning of the war, but over the long term, I think you’ll see customers leave a not reliable and secure supplier.

Sanctions, reputational risk will cause Western companies to pull out support. Most importantly from my perspective, has been export controls. Their infrastructure will suffer greatly over time as a result of the export controls. They’re being denied at this point critical technology and also expertise from the West, which I think over time means it’ll diminish.

The Gulf States have had a windfall as a result of increased energy prices.

And Catherine, I think a notable feature of the crisis has been the emergence of significant government intervention into the energy markets. We see that in Europe as European governments have tried to support their, both their consumers, their population and their industries from high energy prices.

And we’ve seen it of course most recently with the Inflation Reduction Act, which will invest $370bn billion into reducing carbon emissions and increasing domestic energy security, clean energy manufacturing, decarbonization in the United States. This, by the way, I think will end up being one of the most transformative pieces of legislation that we have seen in a long time in the United States.

I think another observation has been the United States has been a really important supplier and support for our European allies with respect to energy supply.

And last, I do think it will have another important dynamic, which is I do think it will enhance and accelerate investments in the transition, and in clean energy decarbonization and clean initiatives.

Catherine: Tom turning to China, you mentioned that China’s reopening was one of the key topics of conversation at the Annual Meeting. China’s reopening and the evolution of US-China relations more generally I think are going to be key drivers of this year’s economic and geopolitical outlook. How are you thinking about China these days?

Tom: Yeah, I think that’s right, Catherine. There was a lot of discussion about China’s reopening, of its economy. I think that reflected three pivots in Chinese policy, really since the beginning of December. There’s a pivot on Covid, pivoting away from zero Covid and actively pivoting to a post-Covid world in China. They’re trying to move there as fast as they can at a significant human cost, by the way.

The second pivot is a pivot towards economic growth. And this was on full display at Davos where Vice Premier Liu He and the Central Bank Governor Yi Gang both were at Davos. And the presentation was that there had been a significant pivot in Chinese policy, that the most important national priority at this point would be economic growth – coming off a year where economic growth was, according to the official numbers, at just 3%, which if you take away the Covid year 2020, is the lowest GDP growth that China’s had in 30 years or so.

And the third pivot was toward more constructive relations with the West, particularly with the Europeans.

That’s what’s on display. There are a lot of issues with respect to each of them. With respect to the economic pivot, I think pushing past Covid, making economic growth the top priority will result in an increase in Chinese GDP in 2023. There are questions obviously that the Chinese have to wrestle with. I think they’re aware of them, right? Which is revitalizing the private sector in China, which has been demoralized as a result of the number of dynamics over the last few years. Creating domestic demand, particularly with enhancing consumer confidence and also providing renewed confidence for foreign investors coming into China. This I do think is going to be the top priority for China coming into this year.

There’s been some improvement in the tone in the relationship between the United States and China. This comes out especially out of the meeting between President Biden and President Xi [Jinping] at the G20 session in Bali where they I think we’re looking to try to put a floor, if you will, under the relationship. I think US-China relations are in the most difficult spot that they’ve been in since the United States formally opened relations with China in 1979. No major agreements coming out of that, but again, some change in tone. Some of the dialogues, which have been shut down in the wake of Speaker Pelosi’s visit to Taiwan, have been opened up, not all of them by the way – most concerningly not in the military area. And Secretary Blinken is following up on the President’s meeting with President Xi with an early February trip to Beijing.

So some positive signs, but I think it is important to note though, that the structure if you will, with competition at the core of US-China relations, I think remains. I still think that’s the core dynamic. You see that on the US side, where there’s I think remains a bipartisan consensus in the United States to take a harder, more competitive line, if you will, towards China.

I do think that the tech decoupling – which is a targeted decoupling, not a wholesale decoupling between the two economies, but a targeted decoupling with respect to those technologies, which the United States judges could enhance Chinese military capabilities – that decoupling will continue, and I think will move beyond just semiconductors. Indeed, National Security Advisor Jake Sullivan has pretty much indicated that we’ll move beyond semiconductors to other foundational technologies.

Catherine: So Tom, we touched on Ukraine. We touched on China. What are some of the other hotspots that you’re worried about going into the year?

Tom: You know, Catherine, one of the dynamics that has come out of the Russian invasion of Ukraine has been a real damage done to the global nuclear nonproliferation regime. And we see that on display in the Russian invasion dynamics itself where essentially the Russians have repeatedly held the nuclear threat out there as a way to constrain attacks on Russia.

[There are] discussions about, whether or not Ukraine made a mistake in the 1990s, by giving up its nuclear capabilities. And there are questions around what lessons will countries learn out of the Russian invasion – talk, because of the increased tensions, of other countries who had heretofore not pursued nuclear weapons in Northeast Asia and in the Middle East – are they considering pursuing nuclear weapons at this point?

And two of the key places I think where this is really front and center is in North Korea and in Iran. And it doesn’t get the kind of attention that the Russian invasion obviously has gotten, because it doesn’t have the same immediacy and it’s not a hot war, obviously. But nonetheless, the North Koreans have rebuffed talks with the United States. They’ve escalated provocations. They’ve been on a missile testing frequency over the last year or so at historically high levels, really levels and frequency that we’d never seen before. They’ve put out a much more aggressive, doctrinal set of statements. So, I think it’s an important place to watch for increased tensions going forward.

A second example is Iran, where negotiations on reviving the nuclear deal between the international community and Iran have hit a standstill. United States officials have indicated that’s not a current top priority, and there’s really not a short-term path forward at this point. The sides haven’t withdrawn totally from the negotiations. Nonetheless, I think that, to the extent that there are no negotiations taking place, that the constraints have been lifted, and Iran continues to push ahead with various dimensions of its nuclear program.

We could see the concern deepening with respect to the program and revisiting of the kinds of discussions we had in 2010, 2011, 2012 around whether or not there should be action taken to constrain the nuclear program. I think this is exacerbated by Iran’s ongoing cooperation and military support for Russia.

Catherine: So there’s a long list of things to be worried about. Anything that makes you hopeful?

Tom: Catherine, we’ve gone through a number of the challenges that we have internationally and domestically. And we do have significant challenges in a fragmented world – in a world where we don’t have the same kind of mechanisms that we’ve had to manage global and other challenges. But there are some things that are, I think, optimistic and I think hopeful signs. I’ll mention three.

Number one has been the resilience, adaptability, diversity of the US economy. We’ll go into a downturn of sorts in 2023. It’s hard at this point to judge exactly what that will look like, but overall, the economy has weathered all manner of crises and shocks in the last few years and done fairly well. We’ve also had the ability as a country – despite degrees of polarization we haven’t seen in many years in the United States, maybe since the Civil War – we’ve also been able to put in place legislative and policy efforts to address our challenges and a number of them done on a bipartisan basis. The Bipartisan Infrastructure Act is an example. The Chips and Science Act is an example. And then we had the Inflation Reduction Act, passed this last year, which is the most significant investment the United States has made in climate and energy policy. So, yes, challenges – economic challenges, societal challenges – but a durable, adaptable and resilient economy and society in the United States.

The second is – I’m really struck by the ability of the international community to respond to meet the multidimensional challenge of the Russian invasion of Ukraine. The Russian invasion of Ukraine, as we discussed, is a global event with a lot of dimensions and challenges – military security, economic, energy, societal. We’ve talked about the refugee flows. And the international community has organized itself in a way to pretty effectively meet that challenge.

And the last I’d mention is technology. I continue to be optimistic about the pace of technological innovation around the world. If you look at the speed and scale of technology developments and the change in important areas like artificial intelligence and climate technologies, I think those are sources of hopefulness and optimism going forward.

Now, the challenge on this will be – and I’ll leave on a negative note on my optimistic answer – is that I am concerned that policy has not kept pace with the challenges the technology presents. I think this has been a problem for a long time in the United States. Maybe it’s a perennial problem with technologies, but this has really been a serious problem since the rise of the internet as the principle economic interface in the world.

And so that’s one concern I do have. I’m optimistic about the technology, but concerned about the ability of policy and policymakers to keep up with the societal challenges that they present.

Catherine: Tom, this has been great as always. Thank you so much.

Tom: Thank you, Catherine.

Catherine: Thank you for listening to this episode of The Bid. Join us for the next episode of The Bid where we’ll look at the top three technology megatrends that will shape the future. Make sure you subscribe to The Bid wherever you get your podcasts.

Sources:

Secretary of Defense Lloyd J. Austin III and General Mark A. Milley Press Conference Following Ukraine Defense Contact Group Meeting, Ramstein Air Base, Germany Jan. 20, 2023

UN Report of displaced refugees in Ukraine as of January 24, 2023;

Internal Ukraine Report October 2022

“The Russo-Ukraine War Ten Months In: Taking Stock” Michael Kopfman, Dec 28, 2022

White House release “Inflation Reduction Act Guidebook” August 16, 2022

Reuters Article Jan 22, 2023 “China’s 2022 economic growth one of the worst on record, post-pandemic policy faces test

This post originally appeared on the iShares Market Insights.

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