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The Strong Global Economy Faces Many Destabilising Factors

March 12, 2018 14:30

Dear traders,

The global economy seems to be finally recovering after years of slow growth, but strong headwinds remain a risk and could derail the recovery.

This article explains why 2017 was a positive year, what factors could destabilise the current growth, and how debt could fuel the next recession.

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Global Economy Reaching Maximum at 3.1%

The global economy is reaching a point of full recovery with a 3.1% growth in 2018, according to the Washington-based World Bank in its report Global Economic Prospects 1. The announcement from January this year, however, also warned that potential future growth remains a concern.

The recovery after the Great Recession of 2008-09 was tedious and much slower than the previous economic recoveries in the 2nd half of the 20th century.

One of the positive exceptions was last year (2017) due to a recovery in investment, manufacturing and trade, but the uptrend is only seen as a short-term upswing. World Bank Group President, Jim Yong Kim, said that "the broad-based recovery in global growth is encouraging, but this is no time for complacency." 2

Global Economy Faces Destabilising Factors

What are the headwinds facing the global economy? Here are the main six factors according to the World Bank 3 :

  1. Central Banks are slowly but surely reducing and removing accommodative policies.
  2. Tightening of global financing conditions.
  3. Escalating trade restrictions and rising geopolitical tensions.
  4. An uptrend in investments is expected to flatten.
  5. The global economy is at or near full capacity, which means that short-term growth cannot be stimulated by either monetary or fiscal policy.
  6. Other long-term factors such as aging of the global workforce and a slowdown in potential growth due to the years of softening productivity growth.

Can these forces be curbed? Yes, but action and initiatives are needed that consider how the long-term potential can be boosted.

Policy makers could be able to curtail these headwinds if they chose to invest in capital, both human and physical, and thereby boost labour force participation and productivity.

World Bank Senior Director for Development Economics added that "reforms that promote quality education and health, as well as improve infrastructure services, could substantially bolster potential growth." 4

Are High Debt Levels the Next Bubble?

The Global Recession in 2008-09 was combated by several remedies, which ensured that the global economic recession did not turn into a depression. It required unprecedented efforts from:

  1. Central Banks in the U.S. (FED), EU (ECB), and Japan (BoJ) via the lowest interest rates possible (0%) and massive quantitative easing (QE) programs.
  2. Governments in the US, China, and partly the EU to keep global demand high by not cutting their budgets too much but rather take on extra debt.

The impact of these policies, however, is that the levels of debt in the West, Japan, and China are at considerably high levels. This debt ballooning was done to dampen the economic downturn in 2008, but there are two key side effects:

  1. The debt could be the trigger of the next recession.
  2. The debt could make it more complex to successfully combat the next recession.

Source: EUR/USD weekly chart, December 2010 to March 2018 (MetaTrader Supreme Edition)

Debt Trigger and Next Recession

There are three main questions that I'm pondering:

Q1: When will the next recession happen?

Predicting when a next recession happens is very difficult and goes beyond the scope of this article. Whether it is one year from now, or perhaps three or five – eventually, a recession is bound to occur when we take history as a measuring stick.

Q2: What will cause the next recession?

This, too, is difficult to forecast, but one scenario sees a rise in inflation in the US, followed by more interest rate hikes, which could make debt repayments more difficult, and potentially start a series of defaults, casting ripple effects on the entire global economy. Other dangers have already been mentioned above.

Q3: What are the consequences when such a recession hits?

The depth of the recession will depend on the policy choices made today. But I personally would expect the next recession to be deeper than the Great Recession of 2008-09 because of the fact that both Central Banks and governments from the US, EU, China, and Japan have used decent debt sizes to combat the previous recession.

The U.S. are usually the first ones to suffer the effects of such as a recession, but also the first to climb out of it. The EU could have even more difficulties with any recovery as the previous crises seems to remain unsolved. Generally speaking, all economic blocks – including the US, EU, Japan, China, and emerging markets – could struggle to climb out of the next recession.

The EU and emerging markets could be hit the hardest. Even now, as the global economy is growing, the unemployment and debt levels remain relatively high in some of the EU and Eurozone member states, which indicates that policy choices made in the EU do not seem to be working 5 6. This is putting pressure on its citizens, who, in turn, are moving away from the traditional political establishment as a protest. The next recession could sharpen these trends and divides.

How would this impact the Forex market? Higher interest rates could send the US Dollar up and the EUR/USD down, but a potential US led recession could cause a reversal again for the EUR/USD. See the chart above for the expected wave patterns.

Wishing you a happy week of trading,

Chris Svorcik

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  1. World Bank
  2. Ibid.
  3. Ibid.
  4. Ibid.
  5. Statista
  6. Statista

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