Geopolitics and Markets – War Is Peace


Buttonwood - The Economist

28 Apr 2014 – After wobbling a bit on Friday [25 Apr 2014], equity markets are rallying again today, despite the threat of renewed western sanctions against Russia and the potential for the skirmishes in eastern Ukraine to turn into a full-scale war. The prospect of a takeover boom seems to outweigh geopolitical risk.

To be fair, equity markets have struggled overall this year and perhaps they would have made more progress if Ukraine had not erupted (although the news on profits should have been enough to give investors pause). But one suspects that investors have become relaxed about the outlook of regional conflicts, ever since the first Gulf War in 1991 did not result in the Middle East being set ablaze as many predicted. Markets have tended to fall in advance of hostilities and then to surge once the first guns were fired; in a financial sense, war is peace, to continue the Orwellian theme of the last two posts.

Eventually, of course, a war may be more economically significant than the markets expect and investors may underestimate the potential damage. Some of the better books on the outbreak of the First World War such as Christopher Clark’s “Sleepwalkers” or Margaret McMillan’s “The War That Ended Peace” show that Europe’s success in avoiding conflict in the first 14 years of the 20th century (in crises such as the Agadir incident or the Austrian annexation of Bosnia-Herzegovina) may have made its leaders too complacent during the summer of 1914. They slipped into war in a fit of absent-mindedness, believing that the others would back down.

Markets are also made up of investors who believe themselves to be rational profit-maximisers, endlessly calculating their advantage. In a sense, they are rather like Sir Norman Angell, the journalist whose book “The Great Illusion” argued in 1910 that war was economically irrational because of the damage it would cause. He was proved both right and wrong in 1914-18; the war was financially disastrous but the leaders went ahead anyway. Sometimes issues of honour or national identity trump economics; Mr Putin is continuing with his sabre-rattling even as his central bank is forced to raise interest rates for a second time within weeks, and his credit rating is cut. Inflation has surged as a result of a weak rouble.

Is there another sense in which “war is peace”, in that peace can only be maintained in an environment where both sides believe the other will go to war? At a conference last week, strategist Dylan Grice used the well-known example of the “prisoner’s dilemma”—two suspects, held in separate cells, know that if both stay silent, they will go free. But if the other one confesses while implicating the first (in return for a short sentence), the silent prisoner will receive a prolonged jail term. Both may end up confessing as a result of the dilemma, and taking the short sentence rather than walking away.

Role-playing experiments where the game is repeated have tested various strategies. A popular approach is “tit-for-tat”; if your fellow prisoner co-operates (by remaining silent), then do the same. But if he rats, rat back on the next occasion. This strategy can, however, like a mafia feud, lead to prolonged escalation once the first betrayal occurs; some strategies thus allow for forgiveness, at least on the odd occasion. In the right circumstances, the players can be locked into a benign process of endless co-operation.

As Mr Grice points out, modern economies depend on trust and co-operation; they would not function if we believed that the goods we bought were faulty, our money and credit was worthless, and so on. But an atmosphere of trust allows the untrustworthy to get away with fraud for prolonged periods, as Bernie Madoff showed. The EU is essentially a group of collaborating nations which (understandably given Europe’s history) have tired of war; when attempting to deal with the non-collaborative Mr Putin, it may be fundamentally handicapped.

The EU is also made up of democracies that are generally perceived to be more reluctant to go to war. But is that a sign of weakness or an indication that the voters, having watched their leaders plunge into conflicts in Iraq and Afghanistan that have cost much in blood and treasure, and may have only added to the terrorist threat in the long term, are determined not to get fooled again?


Our Buttonwood columnist considers the ever-changing financial markets. Brokerage was once conducted under a buttonwood tree on Wall Street.

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