For most of this summer there have been articles galore in the business press warning that rising levels of geopolitical risk would soon be affecting global markets…. which comes on the heels of articles from the beginning of this year warning about the rise of geopolitical risk.  Markets have reacted in a funny way, however — they’re pretty much ignoring it.  Oh, sure, there’s been some effect in some places.  By and large, however, there hasn’t been any systematic retreat from global investment.  Indeed, after a summer of geopolitical turmoil, the State Street Global Investor Confidence Index responded in August by… rising to its highest level ever.

Now it could be that people who scream “geopolitical risk!” don’t know what they’re talking about.  But let’s be charitable and acknowledge that the world seems more unstable now than it did a year ago.  What gives?

On Monday, the Financial Times’ Gideon Rachman tried to explain this puzzle, and offered one compelling explanation:  geopolitics ain’t what it used to be.

The standard response to all this from a political commentator would be to tut-tut about the short-sightedness of investors. But there is another possibility. Maybe the markets are right. Of course, from time to time, a political shock will cause stocks to fall – for a while. But recent experience suggests that the recovery is often surprisingly rapid.
In the first week of trading after the terror attacks of September 11, the Dow Jones fell 14 per cent. But the Dow and the Nasdaq recovered their pre-9/11 levels within months of the attacks.
It has been a long time since international politics really transformed the outlook for investors for years – rather than for weeks or months. The last times I can think of were the oil shocks of the 1970s that followed the Arab-Israeli war of 1973 and the Iranian revolution of 1979.
Since then, the world has been characterised less by geopolitical risk than by the much less often cited idea of geopolitical opportunity.

Rachman is partially correct — but I’d offer two more partial explanations for what’s going on.  First, there’s an inverse correlation between the areas of geopolitical risk and the areas of significant portfolio investments; the money ain’t going to the politically volatile places.  The Middle East is a mess, but since global investors haven’t been terribly keen on investing in Iraq or Syria to begin with, the market reaction is modest.  The same could be said about Ukraine, which was an economic basketcase even before the recent unpleasantness.  For global markets, the big shocks would come from geopolitical instability in Europe *COUGH* Scotland *COUGH* or the Pacific Rim.

Second, if you read the articles on geopolitical risk more carefully, you discover that there’s a hegemonic actor that still carries some significant sway.  Consider this analysis by Barclay Wealth’s Jaime Arguello:

I am a bit surprised the market is not reacting more to geopolitics. In the 1990s and 2000s, when there was a similar combination of geopolitical events, the market was certainly much more sensitive. Perhaps there is already a lot of money that is on the sidelines waiting to invest.
The key driver [of market movements] seems to be the US Fed’s policy. In cases where the data does not surprise, it is really up to what the Fed says and how it says it.

Or this response in a Bloomberg article on rising geopolitical risks affecting the market:

Geopolitical risk is being underestimated and volatility suppressed, thanks in large part to the open monetary spigots at the U.S. Federal Reserve, European Central Bank and Bank of Japan, according to a recent report [Deutsche Bank managing director Raj] Hindocha co-authored.
“It’s the abundant liquidity that has numbed the markets,” he said in a telephone interview yesterday. “Nobody wants to bet against that firepower.”

There are two ways to think about this.  The first is that central banks — in particular the Fed — are numbing market investors to mounting political risks.  The second, however, is that the Fed is doing exactly what it’s supposed to do — ward off unnecessary panic.  And as some of us have observed, it has the power to do it.

Based on the other two reasons for the lack of any geopolitical effect on the marketplace, I lean towards the latter explanation.  Either way, however, the Fed’s continuing power to move and shape markets is being underestimated.  Again.