The ten biggest threats to the global economy

In its latest World Economic Outlook, the International Monetary Fund (IMF) puts the chances of growth in global output falling below the recession threshold of 2pc next year at just one in a hundred. Is this too sanguine a view?

Global recessions are quite rare events, so if you had to put money on it, you’d go with the IMF. Even when one part of the world is in recession, it is more than likely that others will be growing quite strongly, leading to aggregate growth overall.

Yet right now, the world economy is all over the place. Some advanced economies - notably the US and the UK - are rebounding quite strongly, others are sinking yet further into the mire, and almost everywhere, estimates of potential future growth are being revised down.

A year ago, the IMF confidently predicted that by now, a mild recovery would have taken hold in the eurozone. These hopes have been dashed, many would say predictably so. In Japan too, Abenomics is already disappointing the high expectations vested in them.

It is also a very mixed picture in emerging markets; some are still going up, others - such as Brazil - have ground to a halt. The overarching story, however, is one of slowdown.

Put all this altogether and you have what Christine Lagarde, the IMF’s managing director, has termed “the new mediocrity”, a somewhat trite soundbite, perhaps, but one that describes the becalmed overall nature of the global economy quite well.

The IMF is nearly always wrong to some degree in its forecasting, sometimes spectacularly so, as occurred with the financial crisis. Even a becalmed global economy is better than a shipwrecked one, so it is worth asking what could come along to disrupt the IMF prognosis of ongoing mediocrity?

With help from the latest WEO, which details some of these risks, here are what I think of as the top ten threats.

1. Geo-political risk is at its highest since the Iraqi war, and many would argue, much more dangerous, with Russia apparently determined to re-establish its old Soviet borders whatever the economic costs and to relations with the West. Always chaotic, the Middle East has descended into an apparent inferno with severely negative economic consequences for much of the region, never mind the consequences of Western nations getting bogged down in another costly war. Pro-democracy protests in Hong Kong meanwhile threaten an ugly denouement.

2. Both the situation in Ukraine and the Middle East pose a severe threat to oil and gas production, which could cause fuel prices to spike, further adding to deflationary pressures in the West. This might, admittedly, seem the least of our worries at the moment, with oil prices in apparent free fall on fears of reduced demand and oversupply. Falling prices might reasonably be thought of as a boon, except that they also tend to be indicative of something more sinister - a fast slowing global economy.

3. A hard landing in China seems to me to be pretty much hard baked into the system already. This is what the IMF has to say about it. “Real estate investment has been an important engine of growth in China, and it will be challenging to allow the imbalances in the market— including signs of overvaluation in large cities and oversupply in many smaller cities—to correct while preventing an excessively sharp slowdown”. To this should be added the observation that a great many other industries depend on China’s real estate boom, from construction to steel and household appliances.

Credit booms of a similar order of magnitude elsewhere have historically nearly always led to sharp corrections. It is naive to think that China, because it is a command economy, can somehow avoid such an outcome. Admittedly, it can more easily write off, or otherwise monetise, the debt overhang than would be possible in the West, but the idea that this can be done without consequences is for the birds. Investors remain far too sanguine about this threat.

4. Normalisation of monetary policy in the Anglo-Saxon economies could prove highly disruptive to financial markets, grown drunk on years of ultra-easy money. Quantitative easing is due to end in the US either this month or next, with an interest rate rise likely to follow towards the middle of next year. Britain is likely to embark on interest rate rises sooner still. Nobody thinks rates will rise very far, yet in any tightening cycle, markets have a habit of taking things into their own hands . The risks of a disorderly unwind remain quite high, despite all the warnings markets have had of tighter money to come. Higher rates and less easy credit will also have adverse consequences for still stretched household balance sheets.

5. The existential threat to Europe’s single currency has been removed, but it has left the Continent in a state of economic torpor, with even Germany now struggling to achieve meaningful growth. Outright deflation remains a real and present danger, with the authorities apparently incapable of moving fast or boldly enough to nip the condition in the bud.

6. The idea of “secular stagnation”, touted by a number of fashionable American economists, is in my view a somewhat meaningless concept, but there is no doubt that potential growth more or less everywhere has slowed considerably. Business investment has been worryingly reluctant to pick up.

7. This loss of potential growth may have something to do with the size of the debt overhang, which the crisis was meant to fix. In fact the very reverse has occurred since then, with the world economy gearing up even further. The only form of growth the world seems capable of is the credit fueled variety. Total indebtedness - public and non financial private debt - has risen by a further 20pc of global GDP since the crisis. Some of these debts will never be repaid - think public borrowing in Japan and Italy.

8. Grown complacent on easy money, financial markets are once again badly underpricing risk, with spreads compressed and volatility at exceptionally low levels. As already noted, this has so far failed to induce a meaningful pickup in investment, confirming the presence of bubble like conditions.

9. Few of the lessons of the crisis seem to have been learned. House price bubbles, a major contributing cause of the crisis, have re-emerged in a number of advanced and developing market economies.

10. Ageing populations are reinforcing the loss of economic potential, which in turn will leave many countries struggling to maintain their pension and healthcare promises.

Is the IMF right to think there is only a 1pc chance of a global recession over the next year? I'd say that's wishful thinking.