Sunday, January 24, 2016

Global Risks from the World Economic Forum

Investors, companies, governments are always looking ahead. These entities devote millions upon millions of dollars of capital towards the resolution of the future because it scares us. We get scared in groups, and that fear feeds other groups because humans have this superficial trust in one other in risky situations. The recent sell-off of the global markets is just one example of our unconscious belief that others may be right. Large-scale reaction to risky and stressful events can also be seen in the surprisingly large approval rating of Donald Trump's suggestion to "ban all Muslim immigration into the United States." All presidential candidates, like Trump, participated in a healthy, indirect discussion of ideas in response to the risks posed by a large migration seeking to disperse themselves among the developed economies. This moratorium on international issues could be represented by an impressive gathering in January, and every January, called the World Economic Forum. Interestingly enough, a large survey in over 100 countries and economies is put together annually to address some of these global risks that cause irrational responses. The migrant crisis and financial trouble are just two of the dangers discussed in the Global Risk Report 2016. For this article, I'd like to discuss some of the ideas and concerns brought up in this report with special highlights of the economic risks that threaten global stability. The report from the World Economic Forum can be accessed at their website here. The 103-page document presents well-written analysis on important social, political, and economic current events and how they may be expected to evolve in 2016. It is not every day that the human population assembles a document listing all the fears and jitters they have, so let's make use of it.

from Global Risk Report 2015
An interesting part of this survey includes the pooled perception of the global risks from thousands of political, social, and economic professionals from countries across the planet. These top five choices are ranked on their likelihood and their impact on the population, and this chart compares the risks to those that were chosen in the past. This figure can be found on page 11 of the document from the link. Some interesting big picture trends to note are extricated by the color-coding system that links each issue to a larger category.

  • For the events that were considered most likely in the past up to 2016, two different categories dominate the list. From 2007 to 2010, most of the world saw economic risks as the most likely to occur in the given year. Over half of the risks chosen in these years pointed to asset price collapse, slowing production, or oil shocks. Obviously, this trend was caused by the financial crisis that left a lot of professionals questioning their conventional finance knowledge. Because of this large-scale panic in the economy, central banks were handed the problem and forced to come up with a solution. From 2011 to the current year, environmental risks have trumped the other categories in being the most likely to occur. In this period, ecological issues account for over half of those chosen with climate change and concerns over water supply looming in the minds of participants. This trend shows a global shift in perspective from profits to social good that may have been helped along by the flopping of the financial sector. While global warming dangers have been evident since the early 21st century, the emergence of eco-economics is challenging mainstream business models in favor of those that recognize natural capital as a legitimate resource. A refocus on environmental assets could lessen the importance of regular capital and profits.
  • While economic and environmental issues reign supreme as the most likely, there is one category that barely threatens us at all. Participants in the survey only chose technological risks three times in all the years listed. The year 2007 was the only year where one of these issues made the top three. The absence of the fear of technology may rest in its increasing familiarity. A new generation is not pioneering new and ambiguous fronts in this field but instead already firmly grasps its capacity and dangers. The world is no longer growing up into technology but growing up alongside it. Older generations may still see technology as something that is new and developing, but the generation that will control tomorrow realizes that the other issues listed in the survey will be solved with technological breakthroughs and innovations that are being welcomed in both the developed and emerging economies of the world.
  • Just as technology risks are rated as most unlikely, so they are rated as least impactful. There is no doubt that innovations and changes in this category have large impacts, but people seem to fear their risks less. A similar sentiment could have been found in the early 2000's when technology stocks were inflated to prices that didn't reflect their fundamental value. Then, and perhaps now, the human population concentrate on the positivity that radiates from technology while failing to recognize the vulnerabilities networking and automation can create. As the world becomes entrenched with newer gadgets and acclimated to the a globalized networks, the underbelly of computerization may be easier to identify. Instead of sci-fi movies attempting to warn against the dangers of a robot invasion, the Global Risk Reports of the future may provide the caveats we need. 
  • While technology issues failed to make the impactful list, 8 of the last 10 most impactful risks have been economic with "fiscal crises" and "asset price collapse" as the most popular choices. Many more economic risks crowd the 2nd-5th choices for these years as well. Ever since the financial crises and even before then, wariness over the economic systems has been augmented by more complication to the system that rules our money. In the 1990's, the U.S. government allowed a lot of deregulation and globalization to occur which set the stage for the interconnectedness that plagued the financial system when things crashed. During that time (often called "The Great Moderation"), financial crises in the developing Asian countries where assets and currencies constantly collapsed. Financial trust, amidst the fiscal crises of the last thirty years, has migrated to the central banks and their leaders. Investors have increasingly placed importance on the policies and statements coming from the largest monetary institutions in the world. Interest rates have transcended the role of pricing money to a barometer of economic health. The trend of economic risks as the most impactful supports the transfer of trust from private institutions to central banks as fear and doubt continues to linger.
  • The idea that economic problems are often antecedents to social instability is a commonly held principle. The trend of economic risks in the early years has already been identified in both the likelihood and impact surveys, but the current, and developing, pattern of the early 2010's has been defined by the societal category. Four of the last five most likely risks have been societal issues. In addition to being the most likely, societal issues were chosen most often in the impact survey over the past two years. These social maladies that are listed among the global risks are reactions to poor living standards in areas pervaded by major conflict. Some examples would be water shortages in the Middle East as well as the migration crises in Syria. Solutions to the economic enigmas of the developing world were as success as some would hope. The financial crisis exacerbated the globalized poor while geopolitical issues prevented any real cooperation over environmental and societal concerns. This is why global citizens are turning from financial solutions and embracing events like the Iran nuclear treaty and the green Paris agreement. Just as these issues are defining the dynamics of the new generation, so they are majorly affecting the 2016 election in the United States where Democrats and Republicans leave economic decisions behind for the Middle Eastern conflict and assessment of income in
These are just a few of the trends that can be extrapolated from the perceptions about the likelihood and impact of the various global risks. The next section that I want to turn to on this report is labeled "Economic Growth 4.0" on page 16. The authors, in this section, focus on the economic weaknesses pointed out by participants in the survey. Ranking as the most likely and most impactful, "fiscal crises in key economies, asset bubbles, and structural unemployment and underemployment" were the most identified risks. The losses from the major developed markets show the fear and weakness that threatens the interconnected financial structure that prices fixed income, equities, and bonds (both corporate and sovereign). Underneath all of these issues, the continuation and deepening of the energy shock have forced inflation to a nonexistent level and confused central banks. Energy prices were actually selected as the 5th most impactful in this year's survey as major oil exporting countries threaten to bog down the global economy. The dangerous atmosphere created by deflated Brent and WTI crude prices and sluggish capital can be attributed to the amount of debt floating around on balance sheets of private companies and government accounts. The report cites a comment from the IMF in which they estimated a total of $3 trillion of overborrowing and a debt-to-GDP ratio increase of 26% in between the years of 2004 to 2014. In 2015 alone, emerging markets added around $120.5 billion worth of debt to their portfolios despite an uncertainty surrounding interest rates. These high levels of debt were created at a time when energy prices were higher and interest rates were near; the reversal of these trends could mean higher risk premiums on bonds. Currently, U.S. 10 year Treasury bonds are trading near their low 2.00% yield despite the Federal Reserve's plan to increase the Fed Funds rate. Corporate debt could get pricier if a slowdown continues throughout 2016, and sovereign debt premiums could widen as well. Debt-littered euro zone countries could face monetary crises with a devaluation of their currency as well as their government bonds. Greece is just one already urgent example of countries that spend in order to preserve social welfare and stability. While those policies were favorable to the populations, the long run consequences of heavy spending eventually overcome the expensive public goods. Instability in France has already become a concern as President Hollande declared an "economic state of emergency in the country." All of these concerns summarize major downside risks that pervade the global economy, but we haven't even mentioned China.

On page 17 of the Global Risk Report, the authors discuss China's economic status as one of the largest factors influencing global financial health in 2016. Both of the sell-offs in August of 2015 and the beginning of 2016 have been reactions to Chinese asset crashes or sluggish productivity data. The Asian behemoth is now the largest economy in the world accounting for just over 16% of the world's GDP which rivals only the United States. Because of its roles as both an importer and exporter from/to most developing and developed countries, even small changes in the supply and demand can disrupt global market equilibriums. Take oil for example. OPEC, which exports a lot of their heavy crude to East Asia, has been forced to sell at a much lower price with diminishing demand under industrial slowdowns in China. At the same time, the Chinese yuan continues to be devalued by weakness. President Xi has coined a new term for China's condition to inform the world that the manic growth is over. He calls it the "new normal" where "the economy will be based on fewer exports and investments and more services and consumption." Basically, Xi wants his country elevated to the developed status, and this desire can be seen by the Chinese government's push to make the yuan a designated "reserve-currency" by the IMF. He also warns that China's growth rate is not below 7% because of weakness, but because the new normal represents a transition to a service-based economy with a slower growth rate. There may be a reason to believe him too. The Global Risk Report cites an IMF source again that claims the Chinese construction sector has been operating with incredibly high levels of leverage, "a ratio of total liabilities to equities that exceeds 250." While debt like this was sustainable before, the new normal will not sustain rapid growth and capital flow on such a high level. This is exactly why Chinese stocks are experiencing a reality check of considerable magnitude. So what should the rest of the world, that has been relying on China's 10%+ growth rate, do to fill the gap? Central banks might elect to stimulate more, but I would do nothing. These trepidations are necessary to the business cycle and the rest of the global economy. China's growth definitely overheated while wearing out an underdeveloped financial industry. The report mentions the problem of "face worsening asset quality and non-performing loans" which will need to fail in order to solidify the economic development that has been beneficial. One might think of it as letting subprime investments go just as subprime loans could have been allowed to fail. Once again, debt reemerges as the core of the problem. There are tranches of debt that represent the different quality of the risks that are being taken. Chinese investors will soon find out that their risky bets will no longer be supported. Once the Shanghai Composite finds its bottom, look for stronger, flatter, gradual growth to begin. A cleanse might also include a witch hunt with weak companies and weak investments weeded out of the good ones. The "new normal" may be more of an understatement on the global scene, pertinent to only the domestic Chinese economy. With commodity prices nearing their bottom and debt purchases being condemned, perhaps a spark of direct foreign investment could be the key to finding the next China-like economy. My bet's on Africa.

The Global Risk Report discussion highlights many risks that may not center on economic issues. I have chosen not to cover some in order to stay specific to what my previous articles have been loosely based upon. If there are any more requests for elaboration on the Global Risk Report (a very rich document indeed), please let me now, and I will write some more. This article written here may not be the last you hear of the World Economic Forum anyway. So please, I encourage reader interaction/discussion/development. I really just want ideas to flow because, in the end, collaboration can make this information 10 times better.


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