(MONEY Magazine) – Trying to divine how geopolitical gyrations will impact financial markets and economies is a challenging task. That's why business is booming for Richard Medley, head of Washington, D.C.-based research boutique Medley Global Advisers. His job: to give the high-profile traders and corporate clients that pay dearly for his insights an information edge on possible moves by the Federal Reserve and how geopolitical twists may pan out. Here's Medley's take on the global scene.

INSANA: What's your main focus now?

MEDLEY: Well, obviously the hottest spot is Iraq, and [the issue is] whether the administration can get it off the front pages in time for the election. History shows that when administrations are confronted by foreign policy failures, the economy is less important than the models typically predict.

Q: That's true even today, with the economy improving dramatically?

A: The polls we see say that if you combine terrorism and Iraq concerns, they outweigh economic worries for average voters. That's helped keep Kerry tied with or ahead of Bush in most polls.

Cracking the dollar

Q: In the short term, Iraq is affecting everything from the oil markets to the election. What are some longer-term financial implications of the conflict?

A: Well, whether you get a Democratic-controlled Senate and White House or an all-Republican lineup after the election is incredibly important in terms of the fiscal policy and the trade policy paths that you can pursue. Longer run, we're likely watching the end of American hegemony in terms of foreign policymaking for a generation. That's probably the most important revelation from the situation in the Iraqi prisons--that we have sacrificed moral leadership in a very critical way.

You end up in a world where the U.S. gets its way a lot less on trade disputes and is in secular decline as a leader. It may be the thing that finally cracks the dollar after 20 years of everybody worrying about it. A secular dollar decline would keep commodity prices higher than they'd otherwise be and [fuel] a higher inflation rate in the U.S.

Q: What do you think will be the next wave of problems on the global front?

A: Trying to deal with issues like North Korea, Iran, places like that. The bar to any military action by the U.S. is simply impossibly high. Can you really imagine there being a set of circumstances, short of a direct attack on the U.S. by another country, where we authorize an Afghanistan war or an Iraq war again? It is virtually impossible to imagine that occurring, and we are not the only people who know that.

China's challenge

Q: After Iraq, what worries you most?

A: China. How China deals with its attempt to reform its banking industry and slow itself down and comply with the increasing requirements of WTO [World Trade Organization] membership is something the whole world has a massive stake in. Japan is the third hot spot. It's been extraordinarily quiet but extraordinarily successful under Prime Minister Koizumi's economic leadership over the past year. But there's a risk that people don't realize, and that, again, focuses back on Iraq. If, in all this chaos, a significant number of Japanese soldiers were to be killed, Koizumi could be in instant political trouble, and a destabilized Japan would be a real threat to the sense of growth in the world.