Of Sunshine scattered with clouds

12.04.2018

The International Monetary Fund has in recent weeks described its outlook for the economy’s short term future as optimistic, though it warned of black clouds looming over the horizon. While the principal reasons appear to be the end of fiscal stimulus by Central Banks as well as an increase in interest rates, geo-political instability might be playing, once again, an important role.

The International Monetary Fund has in recent weeks described its outlook for the economy’s short term future as optimistic, though it warned of black clouds looming over the horizon. While the principal reasons appear to be the end of fiscal stimulus by Central Banks as well as an increase in interest rates, geo-political instability might be playing, once again, an important role.

These comments reverberate strongly in the background of increased economic tension between China and the US which has created an uncertain climate for big business and supply chains all over the world. In a strongly worded hint to the US government, the IMF recalled that history has thought that protectionism ultimately hurts consumers, particularly the most vulnerable ones, with more expensive products, less choice and reduced technological innovation.

According to Christine Lagarde, IMF Director, governments can challenge these risks and turn them into opportunities if they heeded three important pieces of advice: to avoid protectionism, to strengthen the financial system further, and to introduce initaitive that spur further economic growth in the long term rather than policy decisions that look within the limitations electrocal mandates.

The IMF indicates that growth should be positive in 2018 and 2019, despite at lower rates than the past two years. However, it signals a big red alert on the balooning deficits many countries are registering, which in 2017 reached a staggering 164 trillion dollars, a 40% increase in 2007. China, alone, is responsible for half of this increase.

Geo-political instability

As indicated, this fragility is caused by other factors too. The outbreak of global commercial tensions and the nightmare scenario of possible conflict between the US and Russia over Syria pose significant risks for world economic recovery.

It is therefore not surprising that investors are asking once again where growth is going to come from. The issue is that business (and economic) confidence can be lost within days, yet it is the blood supply of the global economy. Confidence means that consumers need to feel safe and positive about their prospects in terms of salaries, jobs and general well-being. From a business perspective this means that these feel secure about putting capital into investment and production. The economic mood was indeed positive into the last half of 2017 and the start of this year. However recent activities have turned confidence upside down, and early signs of strain are already showing.

Worries of weaker trade, the Syrian escalation, and the ever-present Brexit dilemma pose big questions.

Europe’s business sentiment indices have been hitting record highs thanks to the the European Central Bank’s stimulus package but there are suddenly indications that that momentum is starting to lose traction.  Oil prices have risen more than 10% during the days preceding the strikes, While Syria itself is not a significant oil producer, the wider Middle East is the world’s largest exporter of crude oil and tension in the region tends to put spike prices of black gold.

Add to that, the US-China trade “game” is taking a turn to the worse. The Americans imposed a series of tariffs on a number of Chinese imports, with China responding by announcing tariffs on US imports. If this escalates, tensions could go beyond taxes and disrupt global supply chains. This could have a lasting impact, with companies having to relocate factories or distribution centres. Investment decisions affect employment and can be more disruptive than the imposition of restrictive measures like quotas or taxes. This escalation would be damaging for the US and Chinese economies since global companies invest in both countries. It is still to be seen how far US President Trump will take this.

For the moment, the jury is still out on which way events may turn. The global economic rebound is continuing and other factors, such as the growth experienced by emergent economies, is making up for lost business. Also, some investors are hoping that improved diplomatic efforts as well as political (electoral) pressures could lead to a breakthrough on the trade front and the crisis in the Middle East. Once this hope is lost, however, it might be the finish line for global recovery and financial instability will return.