4 risks to the world economy

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The latest report from the ‘central bankers’ bank’ provides an excellent analysis of what might go wrong in the world economy over the next 2 – 3 years. Anyone interested in scenario planning will find its conclusions valuable. The Bank for International Settlements is the central bankers’ bank. Based in Basel, it contains some of the most expert analysts around. And because it is not attached to any one country, its comments tend to be more objective, as they don’t need to take account of particular political constraints.

The Bank’s newly published annual report is no exception. It notes that the consensus forecast amongst economists is that the ‘recent excellent global performance will continue’. But it then goes on to suggest that there are 4 main risks to this forecast:

• ‘First, a rise in global inflation pressures cannot be ruled out.
• Second, the current slowdown in the United States might prove more significant than expected and the global implications greater.
• Third, global current account imbalances, together with large and volatile capital flows, indicate an exposure to disruptive exchange rate changes with potential implications for financial markets as well as asset prices.
• And finally, with most asset markets already “priced to perfection”, any unwelcome shock might have unexpected consequences.’

It also adds that at the moment the allocation of resources in the US, China and Japan ‘has been moving resolutely in the wrong direction’. It argues that:

• In China and Japan, investment is still focused on export markets, and any economic shock in the Asian region would increase this emphasis as policy-makers sought to protect jobs. In turn, this would stoke protectionist fears in the western countries.
• In the US the recent ‘massive investment in housing has been unwelcome’, as this has not helped to boost the country’s tradable sector and reduce its external trade deficit.

As a result, it seems to imply that the US $ may need to decline more than currently expected, and the Chinese yuan and Japanese ¥ to rise higher, if the required ‘internal reallocation of capital and labour’ in these countries is to be achieved.

It then concludes a rather downbeat assessment of the risks by suggesting that whilst ‘international cooperation has improved in some areas, the political and institutional structure has not kept up with these changing global realities. There is still far too strong a tendency for national authorities to go it alone, and for international dialogue to go no further than that.’

Anyone preparing a strategy paper or budget forecast will find it useful to test their assumptions against a downside scenario based on the risks identified by BIS.

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