Economic recovery No Time for a Split

A stronger dollar and falling oil prices are driving the world's three economic powerhouses apart just when they most need to come together to tackle stagnation.
Neither falling oil prices nor a strengthening dollar can help the world economy.

This wasn’t how it was supposed to be.

At the start of the global financial crisis in summer 2007, emerging industrial nations tried to unhitch themselves from the derailed economic engine responsible for the chaos: the United States. Now that the U.S. economy is again chugging along strongly, the rest of the world is threatening to again uncouple and be left behind as the three most important economic regions on the planet drift apart.

The United States is racing away with a growth rate of 3.5 percent, while Europe’s economies tread water. And after years of economic boom times, the emerging nations of Asia are adjusting not only to lower growth rates, but also to a massive flight of capital.

This divergence of the global economy is exacerbated by major differences in economic and monetary polices, and brings considerable risk to all the regions. The biggest danger comes from the currency markets, where the growing strength of the dollar is rocking the boat.

The rifts between the economic regions are now so great that not even the plunging price of oil can glue them back together.

Even Germany, the European powerhouse, can no longer escape the centrifugal force of the global economy. While exports rose to a record high in October, that’s no longer enough for a general upturn. This has led the Bundesbank, the country's central bank, to halve its growth forecast for 2015 to an anemic one percent.

The rifts between the economic regions are now so great that not even the plunging price of oil can glue them back together.

There have often been differences in growth within the major economic regions in the past, but they could usually be traced to the fact that one progressed a bit more rapidly than the others. Now, America, Europe and Asia are marching in different, even opposite, directions.

In a world of economic interdependencies, this inevitably leads to tension in the financial markets that, in turn, threaten the stability of the global economy as a whole.

Many companies in emerging economies have financed expansion by taking on debt, primarily through dollar-based loans. The Bank for International Settlements, a global organization that fosters international monetary and financial cooperation, estimates that the volume of debt securities issued to emerging markets by foreign investors to be €2.1 trillion ($2.6 trillion).

Economic growth IMF GDP Germany France Euro zone Britain USA China

This pile is a time bomb for German investors because the soaring value of the greenback is creating a dramatic increase in the debt burden virtually overnight. Instead of investing in the future, the companies must now pay higher interest.

Moreover, the strong dollar is forcing down the already weak prices of raw materials even further, diminishing the export income of many emerging economies such as Nigeria, Mexico and Brazil.

As the growth engines of emerging nations splutter, this shortfall in demand will, sooner or later, also strongly impact exporting industrial nations such as Germany. Unlike in 2008, China is no longer ready to ride to the rescue because its economy is also cooling off.

Unlike in 2008, China is no longer ready to ride to the rescue.

Meanwhile, Japanese Prime Minister Shinzo Abe has just catapulted his country back into a recession with an increase in value added tax. All of these factors have a braking effect on economic activity around the globe. Yet even though the major economic regions are drifting apart and dealing with different issues, they cannot break apart.

Whether the global economy gets back into step depends on two factors: the price of oil and correct economic and monetary policies.

Falling prices on the oil markets have the effect of a global economic recovery program. Economists estimate that the world economy will be able to grow by 0.7 percent in the next half year thanks to cheaper oil. Investors, on the other hand, recall the old warning that a long-term drop in oil prices is often the harbinger of a global downturn.

These fears, fed by the general weaknesses in the economies of Europe and Asia, forced stock exchanges around the globe to their knees on Tuesday.

So, what remains is economic policy.

Here again, Europe and the United States have been going their separate ways, at least up until now. Europe is banking on austerity and is hesitating with its long-term monetary policy. On the other side of the Atlantic, however, a credit-financed fiscal policy and an extremely relaxed monetary policy have provided a strong upswing.

Now, an interest rate turnaround is pending in the United States while, in contrast, the European Central Bank is preparing for a massive purchase of sovereign securities. Differences in economic policy are usually adjusted and balanced through the exchange rate. The sharp increase in the dollar, however, demonstrates the risks and shocks to the markets linked to the adjustment process.


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