A look back at one of the most recent major ground conflicts. In August 1990, Saddam Hussein’s army invaded Kuwait. Below are some indicators of risk and uncertainty from that period – some developed later.
figure 1: Top chart, VIX; middle chart, Economic Policy Uncertainty Index, 7-day central moving average; Bottom chart, Geopolitical Risk Index, 7-day central moving average. Red dotted line at the time of the invasion of Kuwait on 8 February 1990; green dotted line at the start of the air raids on 17 January 1991. Source: CBOE, policyuncertainty.com, via FRED, Caldara-Iacoviello.
Higher perceived risk and uncertainty could have implications for the financial sector. Of course, the attack is also linked to actual developments, including the oil price shock.
figure 2: Oil prices, West Texas Intermediate, USD/barrel. Red dotted line at the time of the invasion of Kuwait on 8 February 1990; green dotted line at the start of the air raids on 17 January 1991. Source: US EIA, FRED.
The intrusion and surge of high-risk and uncertainty measures coincided with the NBER peak in 1990M08; a brief recession followed, and a trough was reached in March 1991. (On the other hand, the rise in oil prices and risk and uncertainty measures in 2003 did not coincide with a recession (although as recently as March 2001, on 9/11).
Where are we now?
image 3: Top chart, VIX; middle chart, Economic Policy Uncertainty Index, 7-day central moving average; Bottom chart, Geopolitical Risk Index, 7-day central moving average. Source: CBOE, policyuncertainty.com, via FRED, Caldara-Iacoviello.
Figure 4: Oil prices, West Texas Intermediate, USD/barrel. Source: US EIA via FRED, updated using Tradingeconomics.com.
When viewing the graph, it is important to note that the scales are different. especially, recent peak Geopolitical risk (140) is lower than when Kuwait was invaded (about 200).
Increased risk and uncertainty in the short-term will hit stocks, and in the long-term, if persistent, will dampen investment and economic activity more generally (by reducing aggregate demand). On the other hand, higher oil prices (if sustained) will exacerbate cost-push inflation. Net effect on inflation – ambiguous, going in different directions in the short and long term. The direct impact of rising oil prices on economic activity, I refer to Jim’s analysis (eg, here).
The risks to the world economy are well described, in South China Morning Post.
