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A toxic cocktail for the world economy

Boehme Henrik Kommentarbild App
Henrik Böhme
October 12, 2018

It seems like bad news is springing up from many major economies. Although it's too early to talk of a doomsday scenario, the risks should no longer be ignored, says DW's Henrik Böhme.

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Image: picture alliance/Uwe Zucchi

If one were superstitious, one would have to speak of a bad omen: Just when the who's who of global finance gathered on the famous Indonesian resort island of Bali to discuss the current state of the world economy, the earth beneath their feet began to shake. The start of this year's International Monetary Fund-World Bank Group annual meeting was greeted by a magnitude 6.4 earthquake that struck off the coast of the island.   

It didn't cause significant physical damage, but hardly anyone doubts the potential for damage to the global economy by the dangerous mix of developments that have been shaping up over the past few months.

Read more: IMF: Risks to global financial system rise

The loudspeaker in the White House

Coinciding with the earthquake in Indonesia is, once again, the volcano from Washington: "I think the Fed has gone crazy," fumed US President Donald Trump, who has increasingly taken aim at the US central bank.

But there are plenty of reasons why central banks should be independent in carrying out their responsibilities. And governments, including elected presidents, should hold back and not interfere with monetary policy. Trump is bothered by the Federal Reserve's interest rate hikes. But the Fed's policymakers make their interest rate decisions neither according to whim nor to annoy the president. Instead, their decisions are guided by a sober examination of the economic data. The figures now show that the US economy could face the risk of overheating, and interest rates are being raised to prevent that.

But enough of this monetary policy crash course for the president.

DW business editor Henrik Böhme
DW business editor Henrik Böhme

The fact that Trump's statements contributed to a plunge in stock markets worldwide is only half the story.

In fact, the global economy has been facing increasing headwinds in recent months — from the intensifying trade dispute between the world's top two economic behemoths, the US and China, to crises in major emerging market economies like Argentina, Brazil and Turkey as well as in places like Pakistan.

Furthermore, the world is sitting on a gigantic mountain of debt (amounting to some $182 trillion (can anyone imagine how much that is?) which, if not tackled properly, could cause a major shock to the global economy.    

Other problems include the continuing uncertainty regarding the modalities for the UK's departure from the EU as well as the high debt burden of Italy, which, after all, is the third-largest economy in the eurozone.

All-clear for the time being

Of course, it is definitely too early to draw a doomsday scenario. There are still enough stabilizing factors. There is the very robust US economy. Even for economies in the eurozone, there is currently no risk of infection by a crisis virus.

But you just have to look carefully where the dangers lurk: The US economy is buzzing thanks to numerous stimulating measures such as tax cuts and the aforementioned protectionist measures including punitive tariffs.

These measures are pushing the already gigantic US debt mountain even higher. Moreover, it can be expected that the pendulum will immediately strike back and the US economy will begin to suffer from the countermeasures put in place by America's trading partners (although the word "partner" is no longer an accurate description).

Markets still reeling on growth and trade fears

Debt is also a big issue in many developing and emerging economies. Argentina, for example, has never really overcome the big crisis of 2001, although it has somehow managed to stay afloat. But as investors now prefer to park their money back in the US because of higher returns, Argentina once again finds itself caught by the crisis, with all the consequences it entails: rising prices, austerity programs and job losses, among other things. A vicious circle!

A similar situation is playing out in Turkey. There, an actually successful economic model (put in place 15 years ago by then Prime Minister Recep Tayyip Erdogan) is now being discarded by the very same Erdogan, who has now metamorphosed into an authoritarian president.

Read more: Italy defies EU, IMF by approving controversial budget targets

A vicious circle

Many developing countries are also beset by a number of economic problems, as the example of Pakistan shows. The Pakistanis have embraced China's ambitious infrastructure development projects, as part of Beijing's massive Belt and Road Initiative (BRI), pushing their debt to unsustainable levels. Islamabad has now been forced to go to the IMF begging for billions of dollars of credit. It would also ultimately lead to austerity programs and job losses in Pakistan.

This is, however, not the first minicrash of the year. As early as in February this year, the markets had nosedived before stabilizing just a few days later and then going up again. That sequence of events could again repeat this time round. If the quarterly figures of US multinationals come out reasonably satisfactorily, they will provide reassurance to investors. The EU summit next week could also produce a breakthrough in Brexit negotiations, potentially boosting investor sentiment.

Nevertheless, if more and more countries remain in crisis mode, then sooner or later it will damage global economic growth, hurting particularly the prospects of heavily export-oriented economies like Germany. That is a danger to watch out for.

Boehme Henrik Kommentarbild App
Henrik Böhme Business editor focusing on international trade, cars, and finance@Henrik58