The Case for Reviving a Rules-Based Multilateralism: But what will be America's role?

• Author: Dailami, Mansoor

The reaction of global financial markets to the heightened geopolitical tensions of recent years is paradoxical. Prior to the rout caused by Covid-19, global equity markets were riding high, witnessing a decade-long bull run. Capping the decade, markets rallied to all-time highs, with the U.S. S&P 500 index delivering an annual return of 32 percent, while Germany's Dax and France's CAC both rose 25 percent and Japan's Nikkei gained 18 percent. Emerging market equities racked up gains of around 15 percent. China's CSI 300 index romped ahead by 36 percent.

Several factors were behind the market gains--most notably, extended monetary policy easing after the global financial crisis, and in more recent years, U.S. tax and regulatory reforms that helped boost investor sentiment and spur corporate earnings. Equity markets are also known to trade on behavioral biases that temporarily drive stock prices away from their economic and corporate fundamentals, due to investor overconfidence or other human foibles. But the anomalous relationship between geopolitics and equity markets is worth pausing over. In particular, the degree to which capital markets have been able in recent years to shrug off worries about geopolitical tensions and political conflicts is not explained by familiar market anomalies or mainstream theories of asset valuation and pricing.

Geopolitical portents, as played out in theaters from international trade to global security, have been sufficiently alarming and broadly reported in media in recent years to potentially move markets. Recent events suggest that the world is entering a period of intensified great power competition against a backdrop of changing American domestic and international politics. The worldview that is gaining traction, regardless of what school of international relations one adheres to, is that a new era of geopolitics now beckons. This is often referred to as the "geopolitics of the twenty-first century," or simply "the new geopolitics."

In relation to capital markets, this era of geopolitics is fundamentally distinct from that of the twentieth century in that the primary venue of competition between major powers is in the realm of economic affairs. Much of the focus is on the nexus between national security and international economic relations, throwing aside the past consensus of economic liberalism and open-door policies. A rising China is shifting the balance of global growth toward a multipolar order. A...