The great and good (and the not so good) will meet in Davos this month and no doubt we will hear various proclamations both before and during that event so we at MetalMiner thought we would get in early with details of the World Economic Forum’s Global Risk Report because it contains some interesting issues regarding the risks the global economy faces in the year ahead that may be preoccupying attendees minds.
As an article in the FT explains, the report has been successful in identifying the big risks in the past few years, having flagged up in 2006-2008 issues such as asset-price overvaluations, consumer over-indebtedness, oil and food price jumps and the destabilizing effects of the US current account deficit. Unfortunately it pointedly avoids saying when these risks will manifest themselves as a crisis which is a bit like saying one day it will rain, I just can’t say when. However China is highlighted as one of the biggest concerns in this year’s report, partly because of the way it has responded to the global financial crisis and partly because it is one of the only risks yet to be realized from those consistently identified in the report’s five-year history i.e. all the others have happened but this one hasn’t so it’s only a matter of time is how the theory appears to go. The report says the chances of a serious economic slowdown in China are above 20% and would lead to economic losses of between $250bn and $1,000bn. In total of course the repercussions would be greater than this because of the country’s central role in funding developed country deficits and consuming the majority of exports from its south-east Asian neighbors whose economies would catch a cold if China sneezed.
Of particular concern was high credit growth in China which the report suggested risked mimicking the asset price bubbles and unbalanced growth of the west before the crisis. Commercial lending by Chinese banks grew more than 45% between July 2008 and July 2009, according to data from Swiss Re in the article. To their credit, the Chinese government appears to recognize this risk and is taking steps to reign in further lending.
The other major concern, equally earning a >20% probability of occurrence is asset price collapse in addition to or beyond the asset price destruction we have already seen in western property, commodity and equity values.
Not surprisingly a fiscal crisis is ranked about third in terms of a combination of financial impact and probability of occurrence. Daniel Hofmann, group chief economist at Zurich Financial Services, the global insurance group said that the risks of fiscal crises faced by western countries particularly were not based mainly on “exploding budget deficits but about the current models for health, education and unemployment protection, which in the US and UK especially “are clearly not sustainable. Interestingly he did not mention Japan in that reference yet in a Telegraph article, Japan’s dire financial position was examined in scary detail last week. With the population in outright demographic decline since 2005, the IMF says Japan’s gross public debt will reach 227% of GDP this year. This is compounding at ever faster speeds towards 250% by mid-decade. Yet every year there are less and less taxpayers to fund the government debts while the savings rate will soon crash below zero. The only reason why this has not yet blown up is because investors (mostly Japanese) have not yet had the leap in imagination required to understand their predicament, and act on it says the article. If the analysis is anywhere near correct the risk of another financial crisis is most acute in Japan, and don’t forget they currently hold $750bn or 10% of the entire stock of US Treasury debt, as well as a lot of UK Gilts and Belgian bonds. What will they do with those if they get short of cash?