Many things these days are undermining several widely held beliefs. One is that free trade and globalization promotes prosperity - and thus peace. Another belief is that investment portfolios need foreign diversification. Here are some thoughts whose rough edges will likely be smoothed out in a subsequent writings.
Free trade and globalization after WWII did help bring peace and prosperity to the world for several decades. But it lulled the West into a sense of complacency and there is now concerns about mounting geopolitical tensions, war in Ukraine, hostile rhetoric between superpowers, and nuclear brinkmanship.
The problem with free trade and globalization is the clash with the national security of individual countries. For example, the autocrats see their increased national wealth as a means for funding the projection of power on the world stage, even if millions of lives are at stake (e.g. the unprovoked war in Ukraine). Also, the consequent dispersion of production across countries creates economic dependencies that autocrats can leverage to their advantage (e.g. Russia shutting off gas to EU countries).
Almost forgotten in the West, it seems, are the basic and fundamental responsibilities of governments to safeguard national security and sovereignty. Yes, let’s shift away from fossil fuels by banning pipelines, offshore development and other activities that require a trade-off with economic development and self sufficiency. But let’s also have a balance with other priorities.
Going forward, the world seems destined to retreat into regionalism. World production in essential industries will likely also move back more to their home countries. Indeed, U.S. semiconductor manufacturers like Intel Corp. are now receiving government subsidies for the purpose of shifting production back to the United States. Energy is another industry that could see big changes: namely a shift more toward nuclear power, as France has already done.
Nuclear power is a clean source of power whose safety has improved with technological advances since the Three Mile Island and other reactor accidents. And it does not require much co-operation from the weather like wind and solar do – nor from suppliers in foreign countries. Moreover, there is the prospect of scaling this energy source to a greater potential as research and development carries on into transitioning from fission to fusion.
As discussed in a previous post, the past 19 years of investing with a passive, stock-bond portfolio of Canadian index funds without foreign diversification delivered returns of over 8% annually – at least as good as most professionals. So why take on the extra execution burden, costs and risks of currency fluctuations that come with foreign diversification?
It should be added: why take on the geopolitical risks? Barton Bigg’s book Wealth, War and Wisdom tells us that a rather surprising number of foreign financial markets since the 19th century have disappeared either for periods of several years or permanently, on account of war, revolution and pestilence.