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EUROZONENORTH KOREAPAKISTANVENEZUELARED HERRINGSEGYPTSOUTH AFRICATHE END OF THE 9/11 ERAG-ZERO ANDTHE MIDDLE EASTUSCHINA
 
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3 January 2012
TOP RISKS OF 2012
 As we begin 2012, political risksdominate global headlines in a waywe’ve not experienced in decades.Everywhere you look in today’s globaleconomy, concerns over insular,gridlocked, or fractured politics affectingmarkets stare back at you. Continuationof the politically driven crisis in theeurozone appears virtually guaranteed.There is profound instability across theMiddle East. Grassroots opposition toentrenched governments is spreadingto countries such as Russia andKazakhstan that were thought moreinsulated. Nuclear powers North Koreaand Pakistan (and soon Iran?) faceunprecedented internal political pressure.
Paradoxically, political risk has become so fashionable that its effects are now frequentlyoverstated. Those 2012 political handovers in countries totaling some 50% of the world’sGDP? They’re not such a big deal this year, whether the democratic elections in the UnitedStates and France or managed authoritarian transitions in China and Russia. Moreover, seri-ous challenges to national decision-makers doesn’t mean that governments are all poisedto buckle under pressure. The eurozone isn’t heading toward fragmentation (one of the mostconsistently over-exagerated risks out there). The American economy is more resilient thanmany believe. And a Chinese hard landing? Not if Beijing can help it—and it can—in 2012.So the big challenge, for risk analysts and for corporate decision-makers and investors, isin carefully weighing the risks in a world of ever-increasing information, data, and commentary(much of it noise). Our top risks of 2012 are meant to provide you with tools, signposts, andour best judgments on where all these stories are heading—and on how some stories thatyou’re not reading about elsewhere might prove more important than people think.The most important macro theme for 2012: The world’s key political decision-makers willbe focused heavily on questions of domestic economic stability at the expense of internationalsecurity concerns at a moment when politics is having unprecedented impact on the globaleconomy. This conation of global politics and markets denes the formal end of the 9/11 era,a moment when decision-makers sought to isolate globalization from international securityconcerns. The end of the 9/11 era is our top risk for 2012.1
 
The End of the 9/11 Era
 
2 G-Zero and theMiddle East3 Eurozone4 US5 North Korea6 Pakistan7 China8 Egypt9 South Africa10 Venezuela* Red Herrings
THE BIGCHALLENGEIS CAREFULLYWEIGHINGTHE RISKSIN A WORLDOF EVER-INCREASINGINFORMATION,DATA, ANDCOMMENTARY
 
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3 January 2012
TOP RISKS 2012
THE NEWNIGHTMARES AREOF SPIRALINGDEFICITS, THEEUROZONE CRISIS,AND ECONOMICRELATIONS WITHCHINA
driver. Only in these countries were natural resources especiallysusceptible to resource nationalism and interstate conict.Elsewhere, markets were driven mainly by economic fundamen-tals. Geopolitics was primarily a matter for those concerned withnational security, not with the Nasdaq.That’s no longer true, for three reasons: 1) Emerging marketsare now the primary drivers of global economic growth; 2) Devel-oped states are in structural crisis, and political decisions are anincreasingly important determinant of their economic trajectoriesfor the rst time since the end of WorldWar II; and 3) An overarching rebalancing isneeded between developed and developingstates. How quickly and how successfullythat rebalancing occurs is primarily a ques-tion of political will and political capacity.In short, for the rst time in the era ofglobalization, 2012 reects the full globalconvergence of politics and economics.This will fundamentally drive investor senti-ment toward risk aversion, as investorsfocus on the obvious lack of strong andeffective political leadership in virtually allof the major players. Intriguingly, it will leadto an overestimation of political risks inseveral important cases, especially the eu-rozone, the US, and China. Our red herringsthis year are much more important than usual, because baselineexpectations for those risks have become exaggerated.Concern about macro risks will erode condence in an improv-ing American economy, exacerbate concerns of eurozone crisis,and enhance worries that emerging market growth might provewobbly. Caution will remain an overarching investment principle—lending continued support for the dollar, a reluctance to rebalanceportfolios dramatically toward the growth economies, and a greaterdesire to stay in “safe havens” such as cash and gold. At the end of the 9/11 era, politics is driving the globaleconomy, while economics drives geopolitics. All of this is play-ing out against a volatile G-Zero backdrop of global leadershipin short supply.
2–G-ZERO AND THEMIDDLE EAST
The G-Zero—the inability/unwillingness of major powers to takeon new risks and burdens—will become more obvious aroundthe world in 2012. But the Europeans have the means to solvetheir own problems, however haphazardly; Asia faces even biggerstructural challenges, but they’re longer term. In other regions—Latin America, Eurasia, even Africa—the geopolitics aren’t asturbulent. Thus, once again, the Middle East is a special case:
1–THE END OF THE 9/11 ERA
The end of 2011 marked the formal close of the 9/11 era—thekilling of Osama bin Laden, the withdrawal of US troops fromIraq, and an end date for the war in Afghanistan. In 2012, we be-gin to put the global war on terror behind us. These are positivedevelopments for the economy. But for most, what’s replacing itis of greater concern and far more impactful. It was a truism ofglobalization—economics drives the markets, and national secu-rity drives geopolitics. Banks hire economists and worry primarilyabout the private sector; the governmenthires political scientists and concerns itselfmainly with the public sector. No longer.The culmination of a number of discreteevents and longer-term trends turns thepage on this formula as we enter a worldwhere politics and economics overlapalmost entirely.The war on terror is being subsumed byfears for the global economic balance. Thisis not a conventional or unconventionalweapons threat. It’s not a balance of terroror an individual terrorist. The new night-mares are of spiraling decits, the eurozonecrisis, and economic relations with China.These have become the primary risks tonational security, though there are clearlyother ongoing security concerns for the US.That’s clearest for the country that still matters most, the Unit-ed States. During his rst three years in ofce, President BarackObama eschewed an overarching foreign policy strategy. In part,that was driven by the country’s overwhelming focus on domesticeconomic headaches. But as long as bin Laden was still at largeand the endgames in Iraq and Afghanistan remained uncertain,these inherited concerns dominated the administration’s foreignpolicy agenda.The death of bin Laden, the withdrawal from Iraq, and ac-ceptance that Afghanistan is not amenable to counterinsurgencystrategies have created the Hillary Clinton moment in US foreignpolicy. Secretary of State Clinton has developed a doctrinefounded on economic statecraft and a shift in US foreign policypriority toward Asia, despite continuing instability in the MiddleEast. Asia is the engine of global economic growth; it is alsowhere the long-term credibility of US commitments faces the big-gest potential challenge from a competitor (China). It is thereforeof the highest geopolitical importance. That (accurately) reectsan environment of both risk and opportunity in Asia.Just as economics is driving geopolitics, politics is now mov-ing markets as never before. The role of politics in global marketsis hardly new, but before 2008 the overlap was dened and lim-ited. Only in emerging markets was politics the primary economic
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