21 December 2015

The big economic threats for 2016


Are the greatest threats to economies inevitably political? Even without next year’s Race for the White House, politics in 2016 look like landing three bruising blows on economies from oil, China and Brexit. Oil, arguably the most important price in the World economy, not only plays a critical role in the economic and political stability of the Emerging economies, it also dictates movements in the broader commodity-complex. Notice how, like oil, prices of copper, gold and grains are also rock bottom. How much longer can our key Middle-Eastern allies and other less-friendly commodity producers keep going with oil below US$35/ barrel, or even when it skids down to US$20/barrel as some predict? The answer may be counted in months.

Credit downgrades and social unrest are the common signs of tension, but underneath, disruption to the World savings and banking markets which recycle these commodity revenues are fast compounding the problem. Saudi Arabia may have deliberately triggered the collapse in prices by her political decision to pump more oil, but alongside other producing nations, all must now face the full headwinds of this deflationary storm through 2016.

Hit by these unfolding credit dislocations, the World’s most important exchange rate, the US$/ Yuan that links the number one and number two economies – America and China – has just started to creak. December’s inclusion of the Chinese Yuan in the IMF’s SDR currency basket may seem a technicality, but added to the appearance of a new official exchange rate basket that inflates the influence of non-dollar currencies, they can together produce a thick-enough smoke-screen to allow China’s currency to surreptitiously devalue even more significantly through 2016. Internal debt problems have escalated to such an extent that flight capital is quitting China at a worryingly fast clip. Credit booms never unwind happily, and over the past decade China has engineered the World’s biggest ever credit boom in a feeding-frenzy on imported dollars.

The challenge for China’s politicians in 2016 is to unhook the Middle Kingdom from its dollar dependence. A ‘managed decline’ of the Yuan should allow China’s People’s Bank to release the domestic monetary brakes and boost her economy, but at the cost of exporting Chinese deflation. Instigating a renewed currency war may not be the ideal solution for an already hard-pressed World.

A third political punch in 2016 may come from David Cameron’s upcoming Brexit vote. Some consider this referendum as the ‘price of sovereignty’. Whatever the rhetoric of our incumbent politicians, across Europe and America grass root anti-Washington and anti-Brussels debate appears to be flourishing. Europe has forced us to count in metres, but the EU’s existing political structures worryingly failed in their two bigger challenges: the debt and refugee crises. Putting these together, ironically Europe’s weakest physical borders now coincide with her most fragile debtors, namely Greece. Together with Middle-East tensions, concerns over Chinese bad debts and global deflation, they set a shaky background for the Brexit debates.

The 1930s decade was similarly coloured by currency and commodity price volatility that then led on to political turmoil and eventually to war. Without Britain’s influence, Europe’s centre of gravity will inevitably shift eastwards. Europe may need the balance of Britain more than it realises because geopolitics warns that Germany is a Central and Eastern European power, not a Western one. Could a jilted Germany ultimately be forced to embrace a friendless and economically desperate Russia? The marriage between productive German manufacturing and abundant Russian resources has always had industrial logic.

Compared to these threats from oil, China and Brexit, the most controversial US Presidential Election in decades looks pretty tame.

Michael J. Howell is Managing Director of CrossBorder Capital, a London-based financial research company that advises key investors Worldwide. Prior to founding CrossBorder in 1996, Michael was Research Head at Barings and Research Director at Salomon Brothers. He can be contacted via liquidity.com.