Geopolitics: Middle East contagion has raised geopolitical risk. There is certainly an upside scenario if the demonstrations in Egypt and elsewhere can help the Arab world transition to democracy. But with unrest closing in on Saudi Arabia and Israel at risk of losing its few friends in the region, there is also danger. So long as it's uncertain how things will end up, global markets will be volatile.
One key question is whether this is the Arab world's Berlin Wall or ayatollah moment. Optimists think it is the former. If so, the southern coast of the Mediterranean could over time become prosperous, value human rights and root out corruption. It could then become a valuable trading partner for Europe, just as post-communist Eastern Europe has. The ayatollah scenario scarcely bears thinking about.
But even the optimistic scenario carries huge risks – mainly because of the potential impact on Saudi Arabia, Israel and Iran. Saudi Arabia doesn't look like falling. But as each domino falls – Tunisia, Egypt, maybe Jordan, Bahrain and Yemen – the action will get closer to the world's largest oil producer. From a geopolitical perspective, how Riyadh reacts could be more important than all these countries put together. And it's hard to predict how Saudi would respond to turmoil on its borders.
Meanwhile, it seems pretty unlikely that whatever regime replaces Egypt's Hosni Mubarak will be as pro-American or pro-Israeli as the current one.
The same applies for Jordan, if it gets sucked into the maelstrom. Again, it’s hard to know what Tel Aviv will do if it suddenly finds itself surrounded by less friendly neighbours. Optimists may think it will be more likely to make peace with the Palestinians. But there’s no guarantee that this will be the outcome. It is also unclear how the bubbling up of people’s power in the Arab world will play out in Iran. Tehran says the events in Egypt herald “a Middle East that is Islamic and powerful”. But the uprisings driven by disaffected youth bear similar hallmarks to the green revolution that followed disputed elections in Iran in 2009 and which the authorities repressed. Again it’s possible that there will be some good outcome. But it is also possible to envisage Iran creating more mischief in the region or even behaving irrationally if it feels under pressure.
The reaction of global markets to the fallout has so far been fairly subdued outside of Egypt. True, oil has breached $100 a barrel and the cost of insuring debt in the Middle East has gone up. But equity markets in the West and the Gulf have largely rebounded after an initial fall. Given all the uncertainty, this may be too sanguine.