Geopolitics vs. markets: How might the US, China and Iran reshape global risk?

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Joyce Chang: Welcome to J.P. Morgan's Making Sense. I'm Joyce Chang, Chair of Global Research at J.P. Morgan. Well, what a year it's been for geopolitics and for markets. Cognitive dissonance is a key buzzword this year as the investor mood and market remains clearly risk-on, driven by AI capex investment, even as geopolitical fragmentation persists as a source of uncertainty. So to unpack what the elevated geopolitical risk means today, I'm joined by two special guests, Paul Haenle and Karim Sadjadpour, to examine geopolitical risks focused on what could happen next in the Iran conflict and whether the U.S.-China constructive strategic stability will hold. Now, Paul is head of Asia-Pacific APAC Policy and Strategic Competitiveness at J.P. Morgan. Before joining J.P. Morgan, Paul worked in Beijing for 14 years at the Carnegie Endowment for International Peace. He also served as the director for China, Taiwan and Mongolia Affairs on the National Security Council staffs of former Presidents George W. Bush and Barack Obama. Karim is senior fellow at the Carnegie Endowment for International Peace, where he focuses on Iran and U.S. foreign policy toward the Middle East. He is also a contributing writer for the Atlantic, Foreign Affairs, the New York Times, and the Washington Post. He regularly advises senior U.S., European, and Asian officials and has testified numerous times before the U.S. Congress. Well, Paul and Karim, thank you so much for joining this podcast, and wonderful to have you on Making Sense.

Paul Haenle: Hey, Joyce, happy to be here.

Karim Sadjadpour: Hi, Joyce. It's great to be with you.

Joyce Chan: Well, Karim, let's start with the Middle East given recent events. We're seeing increased attacks, potential disruption or risk around the Strait of Hormuz. At this stage, what are the top objectives from each side? From Iran, from Washington, from the key regional players? After so much escalation, so much lack of trust, what is an acceptable end state?

Karim Sadjadpour: Well, it's an important question, Joyce, and it raises a question I'd actually like to ask of Paul towards the end of my answer. But the bottom line at the moment is that Iran continues to want to exercise control over the Strait of Hormuz, and I don't think that they are going to want to give up that control anytime soon. They believe controlling the Strait is both a revenue stream for them and a deterrent against potential future attacks by the United States and/or Israel. And the challenge here is that, obviously, Iran's Gulf neighbors are deeply impacted. There are some countries like Saudi Arabia who have found alternative routes to get their oil out from the Strait of Hormuz through the Red Sea, although Iran's Yemeni proxy, the Houthis, are threatening to block that channel. The United Arab Emirates is looking at alternative ports, so they're no longer reliant on the Strait of Hormuz. But then there are some countries like Qatar, one of the world's largest producers of LNG, Liquefied Natural Gas, which doesn't really have any alternative routes. And so when President Trump launched the war at the end of February of this year, he laid out several objectives. One was to further obliterate Iran's nuclear program, to destroy its missile program, to destroy its regional proxies, and potentially even unseat the regime. And unfortunately, those objectives, not only have they not really been achieved, but we've, in the process, lost the Strait of Hormuz as an international waterway. And so one question I'd love to know from Paul is how China sees this and whether China is okay with an outcome of Iran charging tolls or charging administrative fees in the Strait of Hormuz. Because certainly no countries in the Persian Gulf want to see that outcome. I would say no countries in Europe want to see that outcome, but given how much of that energy that passes through the Strait is bound for China, China's role here will be very important.

Joyce Chang: No, it's a great question, Karim. And to segue into you, Paul, just in addition to Karim's question, can you tell us what does China want to have happen next from your perspective? And how does this fit into the upcoming summit in September on U.S.-China relations and this constructive strategic stability?

Paul Haenle: Yeah, both great questions. So I think when it comes to Iran, not surprisingly, China sees the conflict as presenting both opportunities and risks. Clearly, on one hand, you hear Chinese experts stressing that China can benefit strategically if the U.S. remains focused on the Middle East and not focused on the Indo-Pacific and China. On the other hand, China does have significant interest at stake. It remains heavily dependent on energy imports from the Gulf. It relies on stable global markets to support its economy. It does want to avoid a global recession that would weaken export demand, especially at a time when China is relying heavily on exports to support its economic growth. Um, I was in China a couple times this spring, both before and after the presidential summit in Beijing. And one thing that struck me was how consistently Chinese interlocutors would emphasize their desire for stability. Whether I was meeting with scholars or business leaders or government officials, even CEOs, there was a, a clear recognition that China can't afford major external shocks while its economy is still facing headwinds and it's trying to regain momentum. And so I think that explains why China's preferred outcome of the conflict in Iran would be a quick deescalation, preserving that regional stability. Beijing wants energy markets to remain stable. They want shipping through the Strait of Hormuz to open up again and then to remain uninterrupted. And Joyce, to your question, they want the broader U.S.-China relationship to remain on more predictable footing, especially ahead of the summit in Washington D.C. at the end of September. So I guess in sum, China is seeking to maximize strategic space while minimizing strategic disruption. And China has concluded that, sure, it can benefit from the U.S. remaining distracted in the Middle East, but it will not benefit from a destabilized world.

Joyce Chang: Thank you so much for that. I mean, a lot of food for thought there as we look at the summit, but everything, Karim, that you have said makes me think that there isn't any quick deescalation of this. So when you look at the key risk ahead, looking at global supply, is it the physical disruption we should be watching? Is it the insurance, the shipping constraints or the political issues? I mean, are there certain risks that you think the market might be underpricing here?

Karim Sadjadpour: So we're speaking today, Joyce, on July 22nd. I would say the two key things that I'm looking at that could impact global energy markets, number one is indeed the Bab el-Mandeb, which is that key corridor from the Red Sea where Saudi Arabia has been exporting most of its oil. And the Houthis up until now, the Houthis are Iran's Yemeni proxy. Sometimes Iran has threatened to close the Bab el-Mandeb, but the Houthis haven't acted. And there's various speculations why that's been the case. It’s been said that the Saudis are, may be paying Houthi salaries. But in the last few days, the Houthis have actually threatened that they are going to close the Bab el-Mandeb. And so that would instantly, remove 5 to 7% of global supply of oil. That's, I think, 5 to 7 million barrels a day on any given day. And so that would immediately have an impact. And if the Houthis were to attempt to do that, that could trigger military action by whether it's Saudi Arabia, Israel, or the United States. So that is one potential shock to keep focused on. The second potential shock is if indeed President Trump makes good on his recent threats to resume military action against Iran, we should expect Iranian retaliations. And oftentimes how Iran will choose to retaliate is at oil and gas installations throughout the Persian Gulf, specifically to spike global oil prices. So I think these are meaningful possibilities in the next weeks. And given that Iran is not showing any willingness to compromise either on giving up the Strait of Hormuz or make meaningful nuclear compromises, I think that is a decent possibility that President Trump will return to military action and the Iranians will likely choose to retaliate.

Joyce Chang: Yeah. So greater military action that could just go on for an extended period is a key risk. And that could even take us through the summer into the China Summit. So Paul, let me turn to you. Do you think that this is going to come up in September at the next U.S.-China summit? What are your expectations for what is going to be discussed? And whether constructive strategic stability will be reemphasized again as the ongoing theme for the rest of Trump's term?

Paul Haenle: So good question, Joyce. And I actually think that the Iran conflict underscores, to a large extent, why China has placed so much emphasis on this new framework for constructive strategic stability, and why both sides, both Washington and Beijing, have an interest in maintaining channels to manage strategic risk, even as the competition continues to intensify. That concept was agreed to by both sides at the Beijing Summit in May. And this is important, I think, for listeners to understand, it does not imply trust or partnership between the U.S. and China. What it does is it recognizes that the U.S. and China are going to remain strategic competitors for the foreseeable future, but that both sides see an interest in trying to prevent competition from escalating into confrontation or conflict. In other words, I think the objective is no longer to avoid strategic competition, it's to prevent strategic competition from becoming strategic conflict. In terms of the summit in Washington at the end of September, President Xi will travel to New York for the UN General Assembly, and then he'll go to Washington, D.C. I would keep expectations modest. One lesson is that these meetings with the Trump administration working with the Chinese side often come together much later than outside observers hope for or expect. And my sense is we're seeing a similar dynamic this time, two months away. I don't think the detailed planning has really begun, or it's at least in the early stages. I don't anticipate major breakthroughs, but I do think the meeting, Joyce, as you're implying, is important to consolidate the understandings that were reached in May. It will not fundamentally, however, change the trajectory of the relationship. And I think that could include further progress on the board of trade, continued work toward establishing a board of investment, additional commercial announcements. We did see a pickup of the military-to-military dialogue after the May Summit. And then, of course, there's an announcement of an AI dialogue between the two sides. So for me, the important question will not be what new initiatives are coming out of the meeting, but it's whether both leaders can reaffirm that direction that they set out in May. And if they do, I think markets will view that as evidence that both governments remain committed to managing that competition, even as the rivalry continues to intensify. Beyond the summit, I would expect competition over things like semiconductors and AI and critical minerals, energy, supply chains to continue to accelerate. So at the summit, I guess in conclusion, what I would say is the real measure of success won't be whether the competition eases, it will be whether it remains manageable.

Joyce Chang: So that's what the market is hoping for, that both sides recognize the benefits of maintaining some type of stability in the marketplace. Well, Paul, let me turn to you because I couldn't ask about U.S.-China without bringing up AI. And your team recently published a terrific report, Beyond the Benchmarks, a report on the U.S.-China AI competition. And so can you tell us a little bit more about this report? How does AI change the dynamics and rules of the game for U.S.-China relations, given that both sides are basically asking for putting some parameters on understanding how to manage the conflict? And what do you think is the most important advantage that each side has?

Paul Haenle: Well, thanks for asking that question about our report, Beyond the Benchmarks. That was something, as you know, that my team developed in collaboration with Terah Lyons and her terrific AI policy team. And one of the reports' central conclusions is that this isn't simply a race to build the best AI model, it is a competition now really to build the strongest AI ecosystem. One that combines innovation, energy, computing infrastructure, manufacturing talent and government policy, and a lot of other things. And to your question, America's greatest strengths remains really unmatched innovation ecosystem, including, of course, leadership in the frontier AI models. We maintain the edge on world-class universities, venture capital and the ability to attract global talent. I guess I would say our greatest vulnerability is building the energy and the infrastructure that we will need to support AI at scale. China, on the other hand, has terrific advantages in its ability to deploy AI pretty quickly across its manufacturing base and its broader economy, and it's putting a lot of emphasis in doing just that. I would say its vulnerability is probably getting access still to the most advanced semiconductors to support AI. More broadly, I think the important point is that AI is no longer viewed in Washington and Beijing simply as a technology issue. It is increasingly seen through that prism of strategic competition. And the real question, is not who builds the best model, the smartest model. It is going to be which country can turn AI into a durable national advantage by translating AI into economic strength, industrial competitiveness, military capability and geopolitical influence. And that's why AI is now so closely connected to energy, industrial policy, supply chains, national security. And so I'd encourage listeners to take a look at the report, Beyond the Benchmarks. It really gives a much deeper look at how we believe the U.S.-China AI competition is likely to evolve over the coming decade.

Joyce Chang: No, the report really does cover the whole ecosystem, and I think it just really lays out the long-term issues, not just where we are and looking at the quarters' capex, which the market is fixated on, but just the longer-term strategic issues and what this means across industries. I have a final question for both of you, but let me start with Karim first. So, Karim, you mentioned just the risk of greater military conflicted escalation, but we're looking across trade, technology, as well as energy security. Is there a single signal that you think is most important for businesses and investors to monitor in the coming year? Is there a surprise risk that you think that from a perspective of watching this internationally, we may be missing on what's happening domestically in Iran? What do you think might be underappreciated that we should monitor ahead?

Karim Sadjadpour: At the moment, Joyce, I don't see any correlation between the negotiations that the U.S. negotiators have been having with Iranians, which they say have sometimes been productive, and they've said that Iran's Senior Revolutionary Guard commanders are starting to rethink the last 47 years of revolutionary ideology and hostility toward the United States. You don't see any signs of that in Iran's public conduct. It's a regime which externally is behaving even more aggressively than it did before the war. So I think in the coming weeks and months, my expectation is that we will continue to see what I call more of a gangster regime in Tehran, in that they seek security in the insecurity of their neighbors. They will continue to try to, you know, benefit from destabilizing the Middle East.  And as we know, Joyce, stability is something that requires billions of dollars to maintain, requires a lot of time. Instability is cheap, as we've learned. $30,000 drones can harass $100 million tankers passing through the Strait of Hormuz. And so, unfortunately, I think that is the lesson that Iran has learned from this war. And at the moment, I don't see any signs that their calculation is starting to shift. I don't see them in the near future offering any meaningful nuclear compromises, and I think they will continue to try to maintain some control over the Strait of Hormuz.

Joyce Chang: Thank you so much. So that's just a lot to take in. And Paul, I have the same question for you on what's most important for businesses and investors to monitor in the year ahead.

Paul Haenle: Let me just try to answer that, Joyce, by building on some of the themes I've already mentioned. First, I think the single most important signal will be whether the U.S. and China can keep strategic competition bounded through mechanisms like constructive strategic stability, like that framework that came out of the May Summit. Again, it doesn't mean competition is easing because it isn't. Competition will remain intense. But again, if both sides can compete with a more stable and predictable framework, I think you'll agree that businesses and investors will have greater confidence to plan, to invest, and then to operate globally.

Joyce Chang: Absolutely. That's what the market is looking for, just not being surprised. And Iran seems like it is still going to be full of a lot of surprises to watch.

Paul Haenle: 100%.

Joyce Chang: Well, with that, I really want to thank both Karim and Paul for joining us today and sharing their insights. For our listeners, please stay tuned for more episodes of Making Sense as we continue to explore the trends that are shaping today's financial markets and the global economy. And I encourage everyone to follow both Karim and Paul's work. Thank you so much, Karim and Paul, for such a terrific discussion.

Paul Haenle: Thank you very much, Joyce.

Karim Sadjadpour: Thank you so much, Joyce. It was wonderful to be with you and my old friend, Paul.

Paul Haenle: Likewise.

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