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Currents and Catalysts: The Macro Pressures Investors Must See

Although the outbreak of civil unrest in Egypt seemed to spring from nowhere, in hindsight it seems as easy to predict as the 2007-2009 financial meltdown. Of course, everything is much clearer with the benefit of hindsight, but would it really have been possible to predict either of these supposed “Black Swan” events? I’d like to make the case that these events could have been anticipated, and that future events triggered by the same underlying forces should be expected as well. 
The mistake most investors make in response to any signs of political unrest in the Middle East is to immediately assume that the risk is unique to this region, and then to search only for signs of political unrest in other countries within this region, particularly those that might impact oil prices.  Rather than neatly compartmentalizing risks and then assuming that they are geographicaly contained, investors should instead seek to recognize the common threads running through seemingly disparate and random events in an effort to determine whether there are any broader destabilizing forces at work. What acted as a catalyst for this outbreak, and could similar pressures serve as the catalyst for other types of instability elsewhere?
Furthermore, when it comes to political risk, it is often argued that identifying potential political risk is easy, but predicting timing is nearly impossible. For example, we have known about political dissatisfaction within Egypt for years, but who could have predicted this sudden popular uprising? The answer is not to focus on the political condition, but rather on the potential catalysts for change, which can be more readily monitored. 
As it turns out, there were three catalysts that contributed to the unrest in Egypt:
  1. The pending transition of power from Hosni Mubarak to his son, Gamal.
  2. Demographic conditions, which are often among the most important contributors to both political unrest and economic conditions, but which are too often overlooked, (ironically, because they are so obvious). 
  3. Higher food prices and lack of opportunity, both of which are felt more severely in stagnant, lower income countries such as Egypt relative to more vibrant, higher income countries where the cost of food represents a smaller percentage of most people’s budgets, and where income opportunities allow individuals to more readily adjust to higher prices.
Now let’s take a brief look at each of these catalysts and assess their broader implications.
The first catalyst, the pending transition of power, gets media coverage but is obviously unique to Egypt, and so is of much less significance to investors attempting to identify potential risks elsewhere.
Of much greater relevance to investors are demographic conditions, in particular the distribution of a country’s population according to age. As noted by Paul Collier in his book, “The Bottom Billion: Why the Poorest Countries are Failing and What Can Be Done About It,” the three most important characteristics of a sample population of Nigerian individuals that made them more likely to engage in political violence were: (1) being young, (2) being uneducated, and (3) being without dependents. Those with a sense of grievance were no more likely to take part in violent protest than those who were not aggrieved. While the Egyptian population is relatively well educated, and the demonstrations were generally not characterized by violence, about two-thirds of the population is under age 30, and the median age is only 24 years. This is quite low relative to the population of the United States, for example, where the median age is 36.8 years, and contrasts even more sharply with Japan where the median age is 44.6 years.

But there are more complex interactions with respect to demographics than just the tendency of younger populations to agitate for change. For example, aging populations present economic growth concerns in developed countries, which in turn prompts fiscal and monetary policies that can export inflationary pressures. These inflationary pressures can have a destabilizing impact, particularly in countries with lower income levels, which generally makes them more sensitive to rising food and energy prices.
As indicated above, a rise in food prices, coupled with a lack of opportunity, was the third catalyst for political unrest in Egypt, at least indirectly. This unrest was first experienced in Tunisia about two weeks earlier, when anger over high food prices and a lack of opportunity finally tipped the population into revolting against Zine el Abidine Ben Ali’s corrupt and dictatorial regime. Higher food prices and rising unemployment arguably played a less important role in Egypt, but the revolt was nonetheless orchestrated under the guise of anger over these economic concerns. In other words, regardless of any interest the military may have had in staging an uprising (which is an interesting discussion I will not get into here) it would not have been possible if a sufficiently large population of mostly younger Egyptians were not catalyzed by their anger over food prices and a stagnant economy.
Higher food prices are the result of both supply and demand factors. On the supply side are the well-documented droughts, floods, and crop failures in various parts of the world over the past year. The growing use of corn as a source of ethanol for fuel, rather than as a source of food, has also had an impact.
On the demand side, rapid economic growth in emerging market countries, particularly China and India, places upward pressure on prices – especially when demand is driven by government policies that don’t respond as readily to the discipline that higher prices impose on potential buyers in more market-oriented economies. There is also the predictable increase in demand that results from stockpiling whenever the future availability of any market good is questionable. Less appreciated, but possibly of equal or greater importance, is the accelerated purchasing that accompanies an increase in inflationary expectations. When such expectations grow, there is a tendency for market participants to buy now before the purchasing power of their currencies is diminished. Speculators may do the same, especially while borrowing costs remain low.
Distorted prices for food, energy, and other commodities, growing inflationary expectations in general, and higher unemployment are common threads permeating the outbreaks of political unrest that we have recently witnessed in the Middle East and surrounding region, and that we are likely to witness in other parts of the world as well.
Interesting as it may be to watch the action in Tahrir square, the root causes of recent developments are what should be commanding the majority of our attention. As investors delve into these macro pressures, it becomes clear that there are deeper currents involved. My goal in this and future articles is to help investors identify and understand the implications of these currents. Stay tuned.