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Analysis
A world of interlocking stalemates

A world of interlocking stalemates

The big problems have been solved – what about the smaller ones?

by David Marsh

Mon 20 Jan 2014

The world has entered the New Year with global risks seemingly under control. The largest geopolitical tensions have dissipated. No one expects a sharp hike in oil prices, a superpower confrontation, a major interstate war, a rerun of the 2008-09 financial crisis, a giant hiatus in GDP growth, the dissolution of a country or the breakdown of a trading or currency bloc.

Checks and balances against disasters are in place everywhere. Breathing a collective sigh of relief, market practitioners are appropriately buoyant. For a year now, stock market values have been pushed up above levels that would appear justified by the relatively subdued growth outlook in major countries.

A closer look shows that the mitigation of risk is due to a series of stalemates all over the world. Self-blocking mechanisms hold in check dangers that would otherwise exert a pall over the world economy. Typical for these ‘capping devices’ for economic and political hazards is the understanding in the euro area that creditors (led by Germany) and debtors (led by Greece) will not expose their mutual vulnerability by taking action that could lead to the single currency’s implosion. Greek debt will be rolled over and eventually forgiven. Germany will pay.

In a similar way, we see a stand-off between China and Japan over territorial claims in the East China Sea; an uneasy balance of hostilities between the Sunni and Shiite denominations in the Islamic world; a cease-fire between the Republicans and Democrats over the US debt ceiling; and tacit accord between Berlin and Paris that neither will lift the veil on the nervous alliance between German strength and French weakness that glues together the European Union.

Elsewhere, in Russia, an authoritarian crackdown by Russian President Vladimir Putin keeps secessionist forces under control. Doves and hawks on the Federal Open Market Committee (FOMC) have engineered a series of stabilising compromises on the right dosage of continuing but diminishing monetary stimulus.

Japanese Prime Minister Shinzo Abe is presiding over an appropriate balance of forces to prevent a damaging spike in Japanese government bond yields that would otherwise be expected to accompany the concerted effort to end deflation.

And the Chinese Communist party is practising levitation – keeping growth at around 7% by preventing excessive debt by Chinese municipalities from triggering a full-scale credit crunch.

The problem with these interlocking international stalemates is that a tip into overt disequilibrium in any of these areas could send out destabilising ripples all over the world. In the same way that the 1987 stock market crash was triggered by US criticism of a tiny rise in Bundesbank interest rates, a brush fire in one part of the world could spark global conflagration.

At the centre of risk-watchers’ radar screens is the potential for even the cautious ‘tapering’ of FOMC monetary stimulus to lead to a drying up of capital flows into a series of emerging market economies. Brazil, India, Indonesia, South Africa and Turkey – all hit by capital and currency market volatility during the upset over what seemed like an imminent switch to tapering last May – are most directly in the firing line. They all face important, potentially disruptive national elections this year. At the same time they must introduce domestically unpopular measures to plug their current account deficits and keep faith with international investors. Other deficit-running economies in Latin America and central and eastern Europe could be affected too.

A good example of how risk-mitigation on one part of the world spills over into risk-enhancement in another is the stabilisation of the euro bloc. A capital and currency market crisis has been averted through a series of deft manoeuvres by the European Central Bank and a mix of harsh austerity and modest reforms by the hardest-hit peripheral countries. But the problems have not gone away. The European crisis has moved to the sphere of politics, social policy and employment.

Sheer arithmetic tells us that the move into current account surplus by a string of indebted euro members, combined with the further rise of the German current account surplus, adds to the pressure faced by developing countries over their own burgeoning deficits.

According to preliminary figures from the Munich-based Ifo economic research institute, Germany's current account surplus last year was $260bn, the highest in the world, equivalent to 7.3% of GDP, once again breaching the European Commission's recommended upper threshold of 6%. The long-running, inconclusive dispute with the US over Germany’s alleged lack of domestic demand leading to an excess surplus is yet another stalemate. And it has a long way still to run.

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