Cracks showing in economic crust

The world’s most active volcanic region is the Ring of Fire girdling the Pacific Ocean. There are 452 active volcanoes and they are constantly studied to see which might be the next to erupt. Reading the International Monetary Fund’s half-yearly global financial stability review feels like a similar exercise. Looking around the world, the experts at the IMF see billowing smoke emerging from the mountaintops and hear the ominous rumble of something getting ready to blow.

A number of developments make the IMF uneasy. The global economy has not recovered the vigour it displayed before the great recession, despite the colossal stimulus provided by central banks and finance ministries.

Indeed, the IMF’s latest assessment is that the trend rate of growth in the global economy has slowed.

Slower growth has been accompanied by extremely low inflation, and that has meant that, even now, six years after the recession bottomed out in the second quarter of 2009, central banks keep delaying the moment at which they will start to remove the stimulus.

Some, such as the European Central Bank, are actually providing additional support to growth.

Add in the fact that the IMF failed to see the last crash coming and that, on average, there has been a financial crisis every seven years in the past three decades, and it is not hard to see why the landscape is being monitored with some anxiety. The warning should be heeded.

On balance, the IMF thinks the next financial crisis is more likely to come from the developing rather than the developed world.

Dollar strength
The review does have some concerns about developments in the West, citing the impact of negative bond yields on the viability of European life insurers. It raises an eyebrow at the still high levels of personal debt in the United Kingdom, which will rise rather than fall on current projections from the country’s office for budget responsibility.

But it has a number of specific concerns about the developing world.

First, a number of oil-producing countries look vulnerable following the halving of the price of crude in the second half of 2014.

Second, the rapid and pronounced rise in the value of the dollar has driven down the value of currencies in the emerging world, exposing those companies that have borrowed in greenbacks to potentially damaging losses.

Finally, there’s the risk of a property crash in China, where the impact of the great recession was dampened by excessive credit growth that resulted in over-investment and a property bubble.

The problem for the IMF’s volcanologists is that, despite having all the latest scientific equipment to monitor movements in the tectonic plates of the world economy, they don’t really know when or where the next eruption will be.

If the crisis happens in one of the emerging market countries identified – Brazil, Nigeria, South Africa or Argentina – there is a chance it will be a localised, if still painful, affair. If it is China, it will be another Krakatoa. – © Guardian News and Media 2015

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Larry Elliott
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