The potential economic flashpoints in 2018

In search of buried bombs

Finance

The IMF expects every major economy to expand in 2018. Yet that was also its forecast in late 2007, for 2008. Although a replay of the global financial crisis is highly unlikely in 2018, there are more than a few ways in which the current rosy projections could go wrong.

A plausible cause of crisis in 2018, as in most recent years, is China. Private, non-financial-sector debt there is now above 200% of GDP, and new borrowing remains worryingly high despite efforts to rein in credit. A slowdown in property-price growth seemingly betokens the end of a debt-fuelled building binge; let us hope it does not herald a crash. 

But if China has the heft and the debt to produce a worldwide crisis, an actual meltdown is not especially likely. China’s government retains tight control over its financial system. That makes it harder for panicky capital to take flight, and it means the world is less financially exposed to troubles in China than the country’s economic might would suggest. And despite growing public debt, the government has the fiscal capacity to manage even a large wave of financial failures. 

A bigger risk than financial crisis is that China is unable to maintain its growth while putting out financial fires. The effect of slower Chinese growth on other economies, from commodity exporters to German robot manufacturers, could increase the world’s vulnerability to some other nasty surprise.

Europe remains a promising source for a bolt from the blue, filled as it is with highly indebted governments, a constraining single currency and rabble-rousing populists. The destruction of the euro zone would generate a crisis to beat that of 2007-09. There are two ways one could occur. Slow growth remains a problem in parts of the euro zone (like Italy). If that were coupled with disappointing reform in a country (like Italy) with enormous public debt, it could lead to a loss of market confidence, rising bond yields and a bail-out bill too large for German voters to accept. Alternatively, a big European country (like Italy) could elect ­
a populist who demands a vote on euro-area membership. 

Luckily, the outlook is improving. The European Central Bank (ECB) has so far seen off market attempts to bid up bond yields. And efforts to strengthen euro-area institutions continue, albeit fitfully. Yet shocks—from Russian bullying, say, or Catalan separatism—are possible. The explosive material for a crisis remains in place in Europe, even if the chances of its ignition have fallen.

What about real bombs? A military conflict with North Korea could send markets into a tailspin. A regional war in the Middle East could cause oil prices to soar, leading to a recession in developed economies that exposes unseen financial vulnerabilities.

But the most probable source of trouble is more mundane: central banks, perhaps grown complacent amid the return of steady growth and the retreat of deflation, tighten policy too much, too quickly. Central banks across the rich world have shifted to a hawkish stance, and they could easily raise rates once too often. The ECB could underestimate the effect of a rising euro on exporters, sending several countries back into recession. And the Federal Reserve could overestimate the strength of American consumers in the face of rising interest rates.

Should they induce a downturn, the scope for efforts to revive struggling economies is woefully limited. Interest rates, close to zero, cannot be cut by much. Debt-obsessed Europe is unlikely to approve a massive fiscal stimulus in response to a slowdown, and dysfunctional America might well prove unable to deliver one. Once a slowdown begins, it could grow much more serious before governments find the resolve to craft an adequate response. But by that time one of the other caches of gunpowder buried around the globe could have blown up spectacularly. Still, as the IMF’s forecasts indicate, all will probably be fine.

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