Blogposts » 2016: A World still in Crisis Mode

2016: A World still in Crisis Mode

Shutterstock / sevenkeShutterstock / sevenke

 

In last week’s post, the GED Team looked at how the world economy might come out of the crises struck 2015. Most predictions assume that economic development will progress slightly more positively in 2016 and 2017 than it did during 2015. However, whether or not this expectation in fact turns out to be true remains to be seen as there are still a number of potential crises and uncertainty factors ahead (as the recent events in China have shown us.)

 

Global risks for the world economy

 

In addition to the slowdown in economic growth in emerging countries, there are at least five other global uncertainty factors:

 

  1. The raising of the base interest rate in the USA in December 2015 makes investing money in the country a more attractive prospect for international investors. However, this could serve to lure capital away from emerging countries. Without this capital, it becomes more difficult for these countries to finance the investments required to improve production capacities and infrastructure. In those countries affected, the decline in private and public investment weakens both the overall economic demand and economic growth. Furthermore, it becomes more difficult for indebted economic players (companies and state institutions but also private households too) to receive the fresh credit that is needed to finance interest rate and principal payments. This threatens to cause bankruptcies, which may in turn lead to financial market and banking crises.
  2. The low interest rate policy employed since autumn 2008 has significantly increased global liquidity. Despite the base interest rate rise in the USA, the global money supply will continue to increase in 2016. In emerging and developing countries, the expansive monetary policy, combined with a devaluation of the local currency, leads to high – sometimes even double-digit – inflation rates (e.g. in Latin America). However, inflation rates remain low in industrialized countries, where liquid funds will mainly flow into asset markets, leading to price increases. This heightens the danger of speculative bubbles bursting.
  3. Moreover, the low interest rates serve to further increase the debt levels of states, companies and private households. In parallel with the bubbles on the asset markets, credit bubbles form there too. In the event that a speculative bubble bursts, this would – similar to the case of the US property bubble and the bankruptcy of Lehman Brothers in 2008 – also cause the credit bubble to burst, with corresponding imbalances in the banking sector.
  4. Even without a credit bubble bursting, the high level of debt – which affects not only the public sector but also the private sector too – represents an economic burden. According to calculations by the McKinsey Global Institute, the worldwide debt level of states, private households and companies amounted to USD 199 trillion in the second quarter of 2014. This corresponds to a debt level amounting to 286 percent of global GDP. If economic actors decide to implement spending cuts – such as lower public spending, lower investment or lower consumer spending – in order to reduce their debt levels, this reduces the overall economic demand for goods and services. If companies react to these decreases in demand with production restrictions, this in turn causes GDP and employment levels to sink.
  5. A further source of increasing uncertainty is the number of geopolitical conflicts, mentioned in last week’s post, which are also set to continue in 2016.

 

Uncertainties in Europe

 

Alongside these global risk factors, there are three additional uncertainty factors emanating from Europe.

 

  1. The Greek debt crisis, for which only a provisional solution has been found: whether the third bailout package for Greece, agreed in the summer of 2015, really represents a long-term solution for the state’s finances and the Greek economy remains to be seen. Should doubts arise about Greece’s ability to fulfil the reform requirements needed to obtain the financial assistance, this would reduce the propensity of companies to make investments and consumers to buy in Europe. This would serve to weaken Europe’s economic development, which would quickly spread across the globe.
  2. The migration of refugees to Europe: the significant increase in the influx of migrants to Europe over the course of 2015 represents an enormous challenge. If consumers and entrepreneurs start to feel doubtful about the EU’s ability to successfully overcome this challenge, this would also reduce their propensity to invest and consume. Furthermore, if an increasing number of states opt to act unilaterally as a means of dealing with the migration of refugees, there is a threat of an economic disintegration, which would have negative consequences on production and employment levels in Europe.
  3. The Brexit: the prospect of the United Kingdom leaving the EU (the so-called “Brexit”): the subsequent disintegration caused by this would have economic disadvantages for the entire EU, leading to lower economic growth, an increased level of unemployment and declining international price competitiveness.

 

So what can we expect?

 

To sum up, a slight acceleration of global economic growth is widely expected for 2016. However, a pre-requisite for this is that the economic and geopolitical uncertainties outlined above do not worsen. A growing uncertainty surrounding the future economic and political development process has a negative impact on the propensity of consumers to buy and on companies’ investment activities. The resulting decreases in consumption and investment demand curb production and employment levels.

In the event that the aforementioned conflicts do in fact escalate, thus leading to violent or even armed confrontations, this would be an exogenous shock. It would render all economic forecasts invalid, and, on a worldwide level, lead to an abrupt decline in production and employment levels. Decision-makers on a political and economic level should be prepared for these dangers, as the world economy will in all likelihood remain in crisis mode in 2016.

 

Note for the reader: Readers interested in matters relating to future global economic development will find “World Economic Outlook” on the International Monetary Fund website. It contains analyses and forecasts for 189 countries for a time period which currently extends to the year 2020.