Looming threat to world economy

Looming threat to world economy
Experts have begun sounding the alarm that a number of factors including rising global debt could ultimately threaten world economy. The International Monetary Fund..

Experts have begun sounding the alarm that a number of factors including rising global debt could ultimately threaten world economy. The International Monetary Fund has noted that this could result in another financial meltdown reminiscent to the one that took place in 2008.

Background

It has been 10 years since the global economy was severely affected by the financial crisis of 2008. Triggered by the sub-prime mortgage bubble, the stock markets crashed, followed by a global recession. In 2017, economists had noted that the world economy was officially in recovery.  The International Monetary Fund (IMF) projected a higher than expected growth for China, Japan and the Eurozone countries like Germany, France, Italy and Spain. Due to the strong performances expected from these nations, global growth is expected to be 3.5%. The OECD has revised its outlook for 2018 global growth from 3.7% in November 2017 to 3.9% resulting from improvements expected in every country, except Russia. Due to the recovery, the Federal Reserve has also increased the interest rates multiple times since 2017. The organization has signalled that it will continue to raise the interest rates in 2018 as well.

However, in recent months, a number of experts have begun sounding the alarm regarding the global economy. There are growing concerns over the real estate bubble in China (details can be found here). IMF economist Obstfeld has also stated that despite growth, recovery may not be sustainable. Jim Yong Kim, the President of the World Bank, has warned that unless nations invest in human development, people across the world will lose millions of jobs to automation and remain unemployed. Germany’s outgoing Federal Minister of Finance, Wolfgang Schäuble, has also warned of the possibility of yet another financial crisis. This is due to increased risks arising from the accumulation of more and more liquidity and the growth of public and private debt.

 

Analysis

One of the main concerns that experts have highlighted with regards to the global economy is rising debt. According to the Institute of International Finance (IIF), global debt hit an all-time high of $233 trillion (£169 trillion) in the third quarter of 2017. This is at least $16 trillion increase compared to the debt as it was at the end of 2016. Analysts note that this is more than three times the size of the global economy.

Due to the “dangerous” levels of debt, the International Monetary Fund (IMF) has warned about the health of global economy. The body stated that the surging price of risky assets is reminiscent of the years before the global financial crisis in 2008. Thus, downside risks to world financial stability have increased “somewhat” over the past six months, said the IMF on Wednesday in the latest edition of its Global Financial Stability Report. “Financial vulnerabilities, which have accumulated during years of extremely low rates and volatility, could make the road ahead bumpy and could put growth at risk,” said the Washington-based fund.

Investors “should not take too much comfort” in the fact there were no major disruptions from the sharp selloff that shook markets in February, the IMF said. “Valuations of risky assets are still stretched, with some late-stage credit cycle dynamics emerging, reminiscent of the pre-crisis period,” it said. “This makes markets exposed to a sharp tightening in financial conditions, which could lead to a sudden unwinding of risk premiums and a repricing of risky assets.”

Former President Barack Obama's chief economic adviser Austan Goolsbee has also warned of the risks that are inherent. Recent market volatility, he said, might indicate that the "Fed is moving too quickly." "There is the possibility that the economy cannot stand too many rate increases in too short of a time," he said. "That would be the thing that leads to a recession."

In addition to these concerns, the World Trade Organization has also warned that if China and the US continue to escalate their trade conflict, the world economy would be ultimately affected.

The IMF recommendation to governments worldwide is: “Decisive action is needed now to strengthen fiscal buffers, taking full advantage of the cyclical upswing in economic activity. It is important to note that building buffers now will help protect the economy, both by creating room for fiscal policy to step in to support economic activity during a downturn and by reducing the risk of financing difficulties if global financial conditions tighten suddenly.”

Vítor Gaspar, the IMF’s director of fiscal affairs, said, “Our debt sustainability analyses indicate that 40% of low-income countries are currently at high risk of or already in debt distress. It doubled in five years. Furthermore, debt service has also been rising rapidly, particularly in countries with high inflation rates. The interest burden has also doubled, in the past 10 years, to 20% of taxes.”

Assessment

Our assessment is that there are a number of factors that might affect world economy and cause a financial crisis in the near future. The main concern is rising global debt, especially the increased debt problems in China. The increased trade tensions between the US and China could also result in a financial crisis. In addition, with investor confidence down, it will become difficult to maintain the momentum that has been built in recent years. There has also been concern regarding a potential military conflict in Syria. A conflict between Russia and the US would immediately affect stock markets across the world and hurt the economy further.

 

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