Four Reasons To Stay Gloomy About the Global Economy.

Commentaries on economics and technology.
Feb. 16 2012 4:56 PM

Austerity. China. The Housing Market. The Middle East.

Four reasons to stay gloomy about the global economy.

(Continued from Page 1)

Third, while U.S. data have been surprisingly encouraging, America’s growth momentum appears to be peaking. Fiscal tightening will escalate in 2012 and 2013, contributing to a slowdown, as will the expiration of tax benefits that boosted capital spending in 2011. Moreover, given continuing malaise in credit and housing markets, private consumption will remain subdued; indeed, two percentage points of the 2.8 percent expansion in the last quarter of 2011 reflected rising inventories rather than final sales. And, as for external demand, the generally strong dollar, together with the global and eurozone slowdown, will weaken U.S. exports, while still-elevated oil prices will increase the energy import bill, further impeding growth.

Finally, geopolitical risks in the Middle East are rising, owing to the possibility of an Israeli military response to Iran’s nuclear ambitions. While the risk of armed conflict remains low, the current war of words is escalating, as is the covert war in which Israel and the U.S. are engaged with Iran; and now Iran is lashing back with terrorist attacks against Israeli diplomats. With its back to the wall as sanctions bite,  Iran could also react by sinking a few ships to block the Strait of Hormuz, or by unleashing its proxies in the region—the pro-Iranian Shiites in Iraq, Bahrain, Kuwait, and Saudi Arabia, as well as Hezbollah in Lebanon and Hamas in Gaza.

Moreover, there are broader geopolitical tensions in the Middle East that will not ease—and that might intensify. The Arab Spring has produced a relatively favorable outcome in Tunisia, where it started, but developments in Egypt, Libya, and Yemen remain far more uncertain, while Syria is on the brink of civil war. In addition, there are substantial concerns about political stability in Bahrain and Saudi Arabia’s oil-rich Eastern Province, and potentially even in Kuwait and Jordan—all areas with substantial Shia or other restless populations.

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Beyond the countries affected by the Arab Spring, rising tensions between Shiite, Kurdish, and Sunni factions in Iraq since the U.S. withdrawal do not bode well for a boost in oil production. There is also the ongoing conflict between the Israelis and the Palestinians, as well as strains between Israel and Turkey.

In other words, there are many things that could go wrong in the Middle East, any combination of which might stoke fear in markets and lead to much higher oil prices. Despite weak economic growth in advanced economies and a slowdown in many emerging markets, oil is already at around $100 per barrel. But the fear premium could push it significantly higher, with predictably negative effects on the global economy.

With so many risks in so many places, investors, not surprisingly, will eventually prize liquidity in their portfolios, while shunning riskier fixed assets again when these tail risks materialize. That is yet another reason to believe that the global economy remains far from achieving a balanced and sustainable recovery.

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