Political Risks to Global Recovery

There are political risks emerging to the global recovery.

The world's economy still flows through the USA regardless of the larger contribution of Asia to the global economy. Asia remains an export driven economy requiring other countries to consume. If the USA slides back into recession, it will cause the global economy to recess.

But there is no evidence the USA is sliding back into recession. The leading indicators are showing a slowing of recovery in the second half of 2010 – but there are no signs of a return to negative growth.

The USA's economy does not seem to be posing a risk to the growing global economy. However, the political risks in the global economy may be posing a risk to the USA.

China / USA Trade Dispute

The core issue in China / USA relations is the value of the Chinese currency. Americans believe the Chinese has set the value of the Renminbi to produce products below fair value.

The USA is pointing to the trade surplus (exports are much higher than imports) that China has developed against the advanced economies.

The issue in America is jobs as over 16 per cent are unemployed or working part time when they want a full time job. It is politically profitable to be seen to try to create jobs. Imports mean products that American's could have been produced were produced using Chinese labour.

A trade war between China and America will cause a contraction in the global economy. It will not end with China and the USA – but politically Europe will join as they suffer the same imbalances as the USA.

It will disrupt the world trade fabric. Multinational business having production in China will be uncompetitive. The exporters to China based in advanced economies will have reduced sales.

Commodity trading partners of China will see reduced demand also. There are no winners in trade disputes.

Southern Europe

The weakest economic performance from advanced economies is being turned in by Europe. The primary cause is the poorly performing economies of Greece and the rest of the southern European economies – Portugal, Italy, and Spain (PIGS).

The root cause of the PIGS problem is the growing debt caused by the PIGS' governments spending more than their tax revenues. The root reason for the income shortfall is the common currency of most countries of Europe – the Euro.

For most of the world, a country's currency, that country's borders, and the country's monetary policy are the same.

For Euro countries, what one country does affects the others – so countries which use the Euro must use a common monetary policy. This means the weak must adhere to the rules of the strong. Weak countries have no ability to devalue currency to become more competitive.

The PIGS' tax revenues are well below the funds required to run their countries. The rules of the Euro Monetary Union have limits to the amount of deficit spending which member countries can undertake. There is no mechanism in place to help the weaker members.

For discussion purposes, let us say there is no problem for the PIGS to cut back spending. These PIGS are consumers of the stronger Euro countries products – they have more imports then exports. So not only would cutting back spending pushing GDP more negative in their own country – they would likely reduce GDP's of the strong Euro countries also.

Whatever the outcome of this PIGS crisis is to the bond markets were their debt is sold, it will definitely reduce GDP for the European Union as a whole.

As economic events are like dominoes, once GDP begins to contract – the overall contraction may end up being much greater.

And if contagion begins in the bond market due to default of any of the PIGS paying off debt – we run the risk of another liquidity crisis and another recession.

The Political Risk

Risk you believe is credible can be defended. Clearly, trade wars are easy to avoid by logical and honest discussions. Since many believe the Great Global Depression of the 1930's was caused by trade protectionism, this belief reduces the likelihood of a trade war breaking out between trading partners following a deep recession.

But nothing is unlikely when driven by political (and not logical) forces. It is political forces in the USA which pushing this issue, and it is political forces in China which are resisting yielding its trade advantage.

Which leads to the PIGS. The resolution of this problem today requires a acceptance by Germany – who ultimately is the anchor of the Euro – to bail out the PIGS. Germany has the strongest economy, and gave up the strongest currency when founding the Euro.

But again we see politics getting in the way of a logical solution. The German voter sees no reason to help the liberal spending PIGS by covering their debt. After all, the German's are very conservative in their fiscal spending policies.

Germany also runs a trade surplus with Euro trading partners. The German people believe their hard work and fiscal sacrifices have placed them in an economically superior position.

It is politically impossible for the export centered economies of China and Germany to yield their dominant positions.

Politics may cause our next recession.

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