For those who like to live life on the edge, 2004 has been a year to savor. It's been a white-knuckle ride as the global economy has defied soaring energy costs, the ever-present threat of terrorist attacks and profound imbalances between the leading players to post what the IMF called the strongest growth performance in almost three decades. There's no mystery as to the reason for this. Put simply, the world has been hauled along by the power of its two locomotives -- the US and China. America's seemingly insatiable appetite for consumption and China's need for investment allowed the rest of the world to bank on export-led growth.
Only Europe failed to make the party. As the year came to a close, there were some signs that next year might be more tranquil. Oil prices came down a bit, the dollar depreciated, the pace of growth moderated from its rapid pace in the middle of the year. In Britain, the heat came out of the housing market without any hard evidence that falling property prices would lead to a repeat of the recession of the early 90s. As a result, it is perfectly possible that next year will be another year of solid growth. The pace of expansion may be a bit weaker than this year, but the trade-off is that it could be better balanced.
There are plenty of forecasters out there -- including the IMF and the OECD -- who think the global economy is on course for a soft landing, and they could well be right. That, however, hardly makes for riveting reading -- so here are five reasons to be worried. The first is that the relatively ordered depreciation in the dollar turns nasty. As Stephen Roche of Morgan Stanley points out, the US dollar fell by 30 percent in the late 1980s when its trade deficit was only half as big as it is today. So far, it has fallen by only 15 percent on a tradeweighted basis, and the expectation has to be that it has further -- perhaps a lot further -- to fall.
For years, what has been happening is that the US has sucked in imports from the rest of the world, and the exporting countries have recycled their foreign exchange reserves into US assets, helping to underpin both the dollar and Wall Street. The house of cards could come tumbling down if the exporting nations lose faith in the dollar at a time when their sales to the US are drying up.
The second reason to be cautious is that there is no effective mechanism for dealing with global imbalances. Designed and built 60 years ago, the global financial architecture is not up to the job of coping with the demands put upon it by an increasingly integrated world economy. Roche's suggestion that the largely ineffective G7 should be boiled down into a G5 -- the US, the Eurozone, China, Japan and the UK -- with a permanent secretariat and some real clout is an idea worth pursuing.
A third potential banana skin is that policymakers have been over-optimistic in assuming that the events of the past few months have merely been a blip. Global leading indicators have been pointing to the slowdown continuing for at least the first half of next year and given that in many countries -- Britain and the US to name but two -- house-price inflation has played a significant role in sustaining growth, there has to be a risk of the bubbles bursting.
The scope for a vigorous policy response should the slowdown persist, intensify and spread is limited given the size of budget deficits in Europe and the US, and the generally low level of interest rates. In this respect, Britain is better placed than most, since base rates of 4.75 percent give the Bank of England ample leeway to loosen monetary policy.