04 October 2004	Monday	18 Shaban 1425

Five major risks threaten the global economy in the days to come. Out of these five risks, three rest with the United States of America: sustainable sharp increases in the current-account deficit leading to a crash of the dollar ; a budget profile that is out of control due to increasing allocation of funds for military; fight against global terrorism; and an outbreak of trade protectionism. especially against China and EU, are the major potential risks to the US which may badly affect the global economies.

The continued and sustained economic growth of China which faces a possible hard landing from its recent overheating, is also a potential future risk/threat to global economy.

The fifth and the last but not the least is that oil prices could rise to $60-70 per barrel even without a major political or terrorist disruption, and much higher with one.

Most of these risks reinforce or are interconnected to each other. Further oil shocks as expected or projected; a dollar collapse and a soaring American budget deficit along with rising interest rates would all generate much higher inflation.

A sharp dollar decline would increase the likelihood of further oil price rises. It is also estimated that larger budget deficits will produce larger American trade deficits, and thus more protectionism and dollar vulnerability.

Occurrence of any one of the five risks could substantially reduce world/global economic growth. If two or three, let alone all five, were to occur in combination then they would radically reverse the global outlook.

There is still time to head off each of these risks. Decisions made in America immediately after 2004 year's elections will be pivotal for future bright prospects of global economies.

It is estimated that China, the new growth locomotive, is supposed to be the key to resolving the global trade imbalances and must play a central role in future. Action by a number of other countries will be essential to maintain global growth and to avoid deeper oil shocks and new trade restrictions.

The most alarming new prospect is another sharp deterioration in America's current-account deficit. It has already reached an annual rate of $600 billion, well above 5 per cent of the economy.

New projections suggest it will now be rising again by a full percentage point of GDP per year, as actually occurred in 1997-2000. On such a trajectory, the deficit would exceed $1 trillion per year by 2010, which would be dangerous not only to USA alone but rest of the world too.

American commodities imports are rated now almost double as large as its exports mainly from China and EU; hence exports would have to grow twice as fast as imports merely to halt the deterioration. In the past, such a relationship occurred only after the massive fall experienced by the dollar in 1985-87.

Economic growth is likely to remain faster in America than in its major markets and higher incomes there increase demand for imports much faster than income growth elsewhere increases demand for American exports.

America's large debtor position i.e. it currently is in the red by more than $2.5 trillion means that its net investment income payments to foreigners will escalate steadily, especially as interest rates rise. These are three reasons for that gloomy panorama.

Moreover, much of the slack in America's product and domestic labour markets will probably have disappeared in a year or so. Sharp dollar depreciation at that stage would push up further inflation and macroeconomic models suggest that American interest rates could even hit double digits.

The situation would be still worse if future increases in energy prices main (Oil and Gas) and the budget deficit compound such developments, as they surely could. The negative impact would also be much greater in other countries because of their need to generate larger and faster domestic demand increases in order to offset declining trade surpluses.

Fears of a hard landing for the dollar and the world economy are of course not new phenomena. The situation is much more ominous today, however, because of the record current-account deficits and international debt, and the high probability of further rapid increases in both. The potential escalation of oil prices suggests a parallel with the dollar declines of the 1970s, which were associated with stagflation.

The prospects for the budget deficit and trade protectionism further darken the picture. The fiscal imbalance at a cumulative $5 trillion over the next decade, but exclude probable increases in overseas military and homeland security expenditures, extension of the recent tax cuts and new entitlement increases proposed by both presidential candidates. All these factors could create deficit of $1 trillion per annum.

Trade protectionism taken as major economic measure by the US policy makers is also one of the major America problem. The leading indicator of American protection is not the unemployment rate, but rather overvaluation of the dollar and its attendant external deficits, which sharply alter the politics of trade policy.

It was domestic political, rather than international financial, pressure that forced previous administrations Nixon in 1971, Reagan in 1985 aggressively to seek dollar depreciation.

The hubbub over outsourcing and the launching of a spate of trade actions against China are the latest cases in point. The current account, and related budget, imbalances may not be sustainable for much longer, even if foreign investors and central banks prove willing to continue funding them for a while.

Chinese unparalleled economic growth is the fourth major potential risk to world economy. It has accounted for over 20 per cent of world trade growth for the past three years is also supposed to be one of the major potential risk to world economy.

Fuelled by runaway credit expansion and unsustainable levels of investments, which recently approached half of GDP. It is predicted that for the sake of balanced world economic growth Chinese growth must be slow.

Under the best of circumstances, China's expansion will decelerate gradually but substantially from its recent 9-10 per cent pace. When the country cooled its last excessive boom after 1992, growth declined for seven straight years.

A truly hard landing could be much more abrupt and severe. Either outcome will, to a degree, counter the inflationary and interest-rate consequences of the other global risks. But a slowdown, and especially a hard landing, in China would sharply reinforce their dampening effects on world growth.

China has just past Japan to become the world's second largest oil consumer, and its demand for oil which grew by 10 per cent in 2003 is expected to increase by 20 per cent this year, or the equivalent of 800,000 more barrels a day.

With the economic recovery in Japan and Europe picking up momentum, the IEA is forecasting a net rise in world demand for oil of 2.8 percent, from 79.1 million bpd in 2003 to 81.3 million bpd this year.

The fifth potential risk/threat to global economic growth is energy prices. In the short run, the rapid growth of world demand, low private inventories, shortages of refining and other infrastructure particularly in America, continued American purchases for its strategic reserve and fears of supply disruptions have outstripped the possibilities for increased production. Hence prices have recently hit record highs in nominal terms.

The impact is extremely significant since every sustained rise of $10 per barrel in the world price takes $250 billion-300 billion equivalent to about half a percentage point off annual global growth for several years.

It is also feared that Gasoline prices per gallon in America would rise from under $2 now to $2.60 in 2006. Prices would climb even more if political or terrorist events were further to unsettle production in the Middle East, the former Soviet Union or elsewhere.

Primarily due to the cartel, the world price has averaged about twice the cost of production over the past three decades. The recent price above $40 per barrel compares with production charges of $15-20 per barrel in the highest-cost locales and much lower marginal costs in many OPEC countries.

This underlying problem also looks likely to get worse, as the Saudis have talked openly about increasing their target range from the traditional $22-28 per barrel to $30-40.

There is a high probability that one or more of these risks to global prosperity and stability will eventuate. The consequences for the world economy of several of them reinforcing each other are potentially disastrous.

All five risks can be avoided, however, or their adverse effects at least substantially dampened, by timely policy actions. The most important single step is for the president of the United States to present and aggressively pursue a credible programme to cut the federal budget deficit at least in half over the coming four years and to sustain the improvement thereafter. This will require a combination of spending cuts, revenue increases and procedural changes as well as rapid economic growth.

China must also play a central role in protecting the global economic growth. China can resolve its domestic overheating problems and contribute substantially to the needed global rebalancing through the single step of revaluing its currency by 20-25 per cent.

Such a currency adjustment would simultaneously address all of China's domestic troubles: dampening demand for its exports by enough to cut economic growth to the official target of seven per cent; countering inflation directly by cutting prices of imports; and checking the inflow of speculative capital that fuels monetary expansion.