A lot of banks and consultancies have now released their outlooks for 2015. There’s a lot to look forward to. The US economy is more healthy than at any time since the crisis, and the UK is following close behind.
But not everything is exactly rosy. Analysts and economists are pointing to some major crisis threats that could derail the warm, Christmassy glow of recovery.
Here are the three bearish scenarios likely to be keeping investors up at night over 2015.
A Chinese Credit Crisis
The possibility of a rapid slowdown and crash for China could have been included in any list of risks for at least the last six years. So far, it’s the dog that didn’t bark, and people who keep forecasting it have looked more like doom-mongers than wise sages. But economist Michael Pettis thinks the idea of hard and soft landings is misplaced, and that it’s better to think of it as the two ways the Chinese authorities could decide to deal with an inevitable growth slowdown:
Beijing can manage a rapidly declining pace of credit creation, which must inevitably result in much slower although healthier GDP growth. Or Beijing can allow enough credit growth to prevent a further slowdown but, once the perpetual rolling-over of bad loans absorbs most of the country’s loan creation capacity, it will lose control of growth altogether and growth will collapse.
China’s credit growth has been extremely fast, and with Beijing cutting interest rates and Chinese equities going parabolic, it certainly doesn’t look much like the state is gently managing the situation. In a separate post, Pettis offers this ominous warning:
I have studied most of the major growth miracles of the past 100 years (and directly experienced some), and in every case there have been pessimists that predicted a difficult adjustment process with much slower growth. … that the pessimists have always been wrong, it always turned out that they were wrong because actual growth turned out to be much worse than they predicted.
Pettis does not expect that the government will handle the slowdown in a disorderly way. But for more pessimistic observers, a major slump could see the world deprived of a major source of demand, which there’s precious little of anywhere at the moment.
Here’s a chart from Nomura showing that Chinese debt has accumulated very rapidly since the global financial crisis:
An Old-Fashioned Emerging Market Debt Crisis:
Claudio Borio, current head of economic and monetary analysis the Bank of International Settlements, think the strong dollar is going to threaten the debt burdens of emerging nations — and cripple growth there. There’s some basic but powerful logic here. In a lot of countries around the world, particularly in the developing world, it’s common for companies and banks to borrow in dollars. So although their day-to-day business might be denominated in pesos, or dinars, or francs, their debt levels depend on how strong that currency is against the dollar.
So when the dollar falls, it’s good news! Your debts are getting smaller in real terms. You need to earn less of your domestic currency to repay them. When it rises (like it’s doing now), that isn’t good news at all! You need to earn more and more to pay back your debts.
This wouldn’t be the first crisis in emerging markets linked to the strength of the US dollar: the Asian crisis in the late 1990s and the Latin American crisis of the 1980s were both spurred by dollar bull markets. Andy Xie, the former Morgan Stanley economist, noted that the coming strength of the dollar would be unpleasant for emerging markets.
What’s more, this year’s Geneva Report (an annual study) noted that there is a lot more debt in emerging markets than there was at the start of the crisis. While emerging nation stock markets have barely grown (they’re actually smaller than they were in 2007), debts have surged.
Debt crisis, in other words, is a bigger systemic risk than an equity collapse in emerging markets:
Euro Crisis Round Two
Europe really can’t handle any more big shocks. The currency union is struggling to generate any visible growth or inflation, and this is meant to be a recovery. It really seems unlikely that the eurozone could weather any major negative economic surprises without slumping into recession and deflation.
Maybe the most obvious catalyst is back in Greece: the current government has to nominate a president in February, and it doesn’t look like it has the votes. To install a president, the coalition would need the support of 180 MPs, not the 155 that it currently has.
If it can’t get the votes, a snap election would be won by left-wing radical party Syriza (based on current polls). The party is in favour of serious bondholder haircuts and abandoning the bailout deals that have been negotiated with international authorities. That would almost certainly send bond prices crashing and yields surging for Greece like they did in during the crisis (rapidly raising the cost of issuing debt). Syriza aren’t the only new anti-austerity party leading in southern Europe: Podemos are in the lead in Spain.
Here’s Citi’s global outlook for 2015 on the rise of anti-establishment parties on both the left and right in Europe:
Future developed country elections will likely continue to see the popularity of new — and not so new — anti-establishment parties, from France’s National Front to Greece’s Syriza to Spain’s up-and-coming far-left Podemos, increasing the risk of fragile multi-party coalitions and reducing the already limited political capital of leaders. In our view, the appetite for political alternatives will endure for many years to come, and their public support could increase in the event of a triple-dip European recession.
Podemos has captured the public debate in Spain, and is dipping in and out of first place in political polling: