No. 974 - Politics will tear us apart, again. Geopolitical risk, fragmentation, and capital flows
The rise in international tensions and the strategic use of economic tools by governments have drawn new attention to how geopolitics affects global finance. Concerns about financial fragmentation are growing, where the term refers to the reallocation of capital flows along lines of political and ideological proximity.
This paper outlines the main indicators of geopolitical divisions and risks, summarizes the empirical contributions on the subject (based on data up to 2024), and identifies some open questions regarding the implications for risk-free assets, the global financial cycle, and reserve currencies.
Geopolitical risk reduces capital flows, especially in emerging countries, while political distance among states is playing an increasingly important role in cross-border investment decisions. In the euro area, after Russia's invasion of Ukraine, this trend has involved both outward foreign direct investment and, to some extent, holdings of European government bonds by third countries.
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09 October 2025
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