Why 2016 will be a year of living dangerously

As in comedy, the key to economic forecasting is in the timing. Economists have been widely and correctly mocked for failing to foresee any risk of a global financial crisis in 2007. But anyone who issued Cassandra-like predictions of a crash in 2005 was equally derided.

Few people - if anyone - predicted that in 2015 Russia would annex Crimea, that oil prices would fall below $40 a barrel, that Daesh would capture the Iraqi city of Mosul or that Chinese shares would fall by 45% between mid-June and mid-August.

But anyone expecting a happy new year after 2015 saw economic growth slow as commodity prices and emerging economies crashed while terrorist outrages and a refugee crisis sapped morale will have been disappointed.

Just a week into 2016 has seen the Chinese stock market suspended twice amid tumbling share prices on fears of a major slowdown, the mass execution of 46 prisoners by Saudi Arabia ratchet up tensions with Iran and North Korea allegedly test a hydrogen bomb.

Because these “known unknowns” are unpredictable, public sector institutions and private sector banks are compelled to issue economic forecasts based on the idea that next year will be the same as last year but with a few tweaks. For instance many economists say that the UK economy will grow by 2.3% in 2016, up from 2.2% in 2015. Probably right…but maybe not.

The wise course is therefore to look at the risks and try to give some weight to them both in terms of how likely they are to crystallise and what the impact would be if they did.

There is no shortage of “known knowns” that could derail an economic recovery that is still looking pretty anaemic nine years after the onset of the crisis.

Top of the list right now is an outbreak of a prolonged Sunni-Shia conflict as mounting tensions between Shia Iran and Sunni Saudi Arabia become uncontrollable. Nouriel Roubini, a professor at New York University and one of the few economists who can claim to have warned about the 2007 crisis, says this would be akin to Europe’s Thirty Years’ War between Catholics and Protestants.

Second, China could be on the brink of a major slowdown that would both create internal risks of mass unemployment, poverty and civil unrest but also lead to a ripple effect across the emerging economies that are dependent on Chinese growth.

Third the high levels of government, corporate and household debt that have amassed in recent years will make many economically vulnerable as the planned hikes in US interest rates are echoed in the rising cost of borrowing on financial markets.

At the same time it could suck speculative capital back out of emerging economies that had attracted investment on the basis of their higher interest rates and strong currencies. The World Bank has warned that a one percentage point in borrowing costs translates in a decline of 20%-45% in the level of capital flows.

Finally the bonds holding our globalised economy together could weaken. An exit by the UK from the European Union is looking less unlikely in the wake of recent opinion polls, at which point Scotland would look to leave the UK. Elections in Spain have put an independent Cataluña firmly on the agenda.

The decision by some eastern European member states to build fences to keep out some of the 1.1 million refugees from large parts of the Middle East and Africa may herald the collapse of the Schengen Agreement on a borderless Europe.

STRONG ECONOMIC GROWTH WILL MEAN BETTER LIVING STANDARDS FOR AMERICANS

But despite the grim start to the year it is important to remember that there is some potential for what economists call upside surprises, which are often overlooked in the media’s focus on the negatives.

The decision by the US Federal Reserve to raise interest rates is a reflection of the recent strong performance of the world’s largest economy and a sign of confidence of that continuing.

Strong economic growth will mean better living standards for Americans and more demand for imports from emerging economies to offset any China slowdown. A stronger dollar will mean more competitive exchange rates for its trading partners.

The fall in the oil price to new lows may be tough for those benign Gulf regimes but it is great news for western economies. If oil prices hold at their current low level, the average household’s spending power could rise by around £370 a year, according to analysis by PwC.

Western allies may continue to help local forces seize back territory from Daesh. A vote by the UK to stay in the EU would trigger a new feeling of solidarity across Europe amid signs that the eurozone is finally (again) turning a corner.

None of these risks may crystallise but the point is that the coming 12 months will be a period of great uncertainty. The halcyon days of uninterrupted low inflation, strong growth and steady rises in wealth that we enjoyed after 9/11 and before the financial crisis are long gone. Instead to borrow from a long-forgotten Australian film, 2016 will be a year of living dangerously.

More about the author

About the author

Phil has run Clarity Economics, a London-based consultancy, since 2007 and, before that, was Economics Correspondent at The Independent.

Phil won feature writer of the year Work Foundation Work World media awards in 2009, and was commended by the Royal Statistical Society in 2007.

He is the author of Brilliant Economics and The Great Economists.

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