After the turbulence of the past two years, the consensus among economic experts is that 2022 will be calmer. But at the end of 2019, when the first reports of a new coronavirus began to filter from Wuhan in China, few imagined in a few months that the world economy would be flattened by a pandemic. So what are the major risks for the coming year?
A new Covid variant derails the global economy
It’s too early to tell how serious the Omicron variant of the virus will turn out to be, but it has already given hope that life is on the verge of returning to pre-pandemic normality. Consumers did not need to be instructed to obey the restrictions; often they have tempered their own behavior. A return to large-scale blockades would have much more serious consequences.
Dhaval Joshi, economist at BCA Research, says more and more variants will emerge and one of them will cause problems. The danger of a variant comes from three properties, he says: its contagiousness; its ability to evade vaccines and natural immunity; and the severity of the disease it causes. “The big issue is not whether the omicron variant is a ‘super variant’. The big problem is that, finally, a new variant will be a “super-variant”.
Inflation takes off
The unexpected resumption of price pressures has been one of the big stories of 2021. The Bank of England, the US Federal Reserve and the European Central Bank have all been caught off guard by a surge in inflation, caused through a combination of rising energy prices, labor shortages and supply side bottlenecks. The Bank of England expects the annual increase in the cost of living to exceed 5% by next April, but then start to decline.
But central banks will face tough decisions if inflation turns out to be more entrenched than they expect. Just before Christmas, Saxo Bank presented its 10 ‘scandalous’ predictions of unlikely but underestimated events for 2022 and one of them was a wage-price spiral in the United States pushing inflation into the world’s largest economy above 15%. Even a much smaller hike would prompt the Fed to aggressively tighten policy.
China hits the pads and gets nasty
For years there has been speculation that the world’s second largest economy is about to experience a severe economic downturn and it has not happened. But the legacy issues have now started to merge with the current struggles to create what could turn out to be a perfect storm.
The problems of the past are exemplified by Beijing’s attempts to deal with the failed real estate company Evergrande and prevent its problems from infecting the entire economy. Along with many other companies in the industry, Evergrande flourished when Beijing relaxed its policies and encountered problems when authorities took action to deal with the overheating economy. China has taken a risk-free approach to Covid-19 and has been at the heart of the global economy’s supply problems. As the economy has cooled, Xi Jinping’s nationalist rhetoric has intensified, especially towards Taiwan. The economy and geopolitics threaten to collide in 2022.
A crisis in emerging markets
The 30% drop in the Turkish lira in November alone alerted financial markets to the dangers of a crisis in emerging markets. In truth, most of Turkey’s problems are country specific, caused by Turkish President Recep Tayyip Erdoğan’s unorthodox approach to monetary policy. Currency traders weren’t impressed by Erdoğan’s insistence that the way to deal with soaring inflation is to cut interest rates. Confidence in the other large emerging market economy seen as high risk – Argentina – is also lacking.
There is a more systemic problem, however, which is that many emerging markets have borrowed heavily in US dollars, often using future export earnings as collateral. Should the US Federal Reserve tighten its policy, the dollar would have to strengthen, making it more expensive to service the debt of the poorest countries. If the global economy slows down as well, they will face a double whammy. The World Bank and the International Monetary Fund are already warning of an increase in debt overhang.
A financial crash
The prices of assets – stocks, bonds and properties – have all risen since the initial sale at the start of the pandemic. Lower interest rates and the flooding of financial markets with money created by quantitative easing programs have made it cheaper to move and borrow money for speculative activities.
Asset prices have also been inflated by the message sent by central banks that any policy tightening will be limited and gradual. But economies began to slow after a period of catch-up growth in the aftermath of the lockdowns. The risk is that despite weaker activity, central banks will be forced to take more drastic monetary policy actions due to higher than expected inflation, thus canceling out the support that was supporting high-value assets. .