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Opinion: Roubini: These risks could stall a global economy that is finally on the verge of faster growth

NEW YORK (Project Syndicate) — For the past two
years, the global economy has been growing, but it has swung
between periods of rapid expansion and deceleration. During
this period, two episodes, in particular, caused U.S. and
global equity prices to fall by about 10%. Is a pattern
emerging, or is a fitful global recovery set to stabilize?

The first episode came in August/September 2015, when many
observers feared that China’s economy could be headed for a
hard landing. The second episode, in January/February 2016,
also stemmed from concerns about China. But investors were also
increasingly worried about stalling U.S. growth, collapsing oil
and commodity prices, rapid interest-rate hikes by the U.S.
Federal Reserve, and unconventional negative-rate monetary
policies in Europe and Japan.

Each deceleration episode lasted for about two months, at which
point the correction in equity prices began to reverse.
Investors’ fears weren’t borne out, and central banks began to
ease their monetary policies; or, in the case of the Fed, put
rate increases on hold.

As a third example, one could cite the period following the
United Kingdom’s Brexit referendum in June 2016. But that
episode was more short-lived, and it didn’t cause a global
slowdown, owing to the small size of the U.K. economy and
monetary easing at the time.

In fact, in the months before U.S. President Donald Trump’s
election last November, the global economy actually entered a
new period of expansion — albeit one in which advanced and
emerging-market economies’ potential growth remained low.

We may still be living in what the International Monetary Fund
calls the “new mediocre” — or what the Chinese call the “new
normal” — of low potential growth. And yet economic activity
has started to pick up in the U.S., Europe and the eurozone,
Japan, and key emerging markets.

Owing to new stimulus measures, China’s growth rate has
stabilized. And emerging markets such as India, other Asian
countries, and even Russia and Brazil — which experienced
recessions between 2014 and 2016 — are all doing better. So,
even before the U.S. presidential election had inspired “Trump
trades,” a “reflation trade” had signaled a new phase of modest
global expansion.

Recent economic data from around the world suggest that growth
could now accelerate. And yet one cannot rule out the
possibility that the current expansion will turn into another
global slowdown — if not an outright stall — if some downside
risks materialize.

For example, markets have clearly been too bullish on Trump.
The U.S. president won’t be able to pass any of the radical
growth policies he has proposed; and any policy changes that he
does make will have a limited impact. Contrary to what the
administration’s budget projections claim, annual economic
growth in the U.S. has almost no chance of accelerating from 2%
to 3%.

Read: What 10 million simulations tell us about
President Trump’s chances of achieving 3% economic growth

At the same time, markets have underestimated the risks of
Trump’s policy proposals. For example, the administration could
still pursue protectionist measures that would precipitate a
trade war, and it has already imposed migration restrictions
that will likely reduce growth, by eroding the labor supply.

Moreover, Trump might continue to engage in corporatist
micromanagement, which would disrupt the private sector’s
investment, employment, production, and pricing decisions. And
his fiscal-policy proposals would provide excessive stimulus to
an economy that is already close to full employment. This would
force the Fed to raise interest rates even faster, which would
derail the US’s recovery, by increasing long-term borrowing
costs and strengthening the dollar.

Over the next year, Trump will have the option of appointing
five, and possibly six, new members to the Fed’s seven-member
Board of Governors.

Indeed, Trump has introduced such profound fiscal uncertainty
that the Fed could make a mistake in its own policy-making. If
it doesn’t increase rates fast enough, inflation might balloon
out of control. The Fed would then have to hike rates rapidly
to catch up at the risk of triggering a recession. A related
risk is that increasing rates too slowly could lead to an
asset-price bubble and all the dangers — frozen credit markets,
soaring unemployment, plummeting consumption, and more –
implied by its inevitable deflation.

Read: Slower U.S. job creation is usually a bad
thing. This time, it might be a good sign

The current Fed chair, Janet Yellen, is unlikely to make a
mistake. But over the course of the next year, Trump will have
the option of appointing five, and possibly six, new members to
the Fed’s seven-member Board of Governors. If he chooses
poorly, the risk of serious policy errors will increase
substantially.

Markets are also underestimating today’s geopolitical risks,
many of which stem from Trump’s confused and risky foreign
policies. Indeed, the global economy could be destabilized by
any number of scenarios involving the U.S. A military
confrontation between the U.S. and North Korea now seems
plausible. So, too, does a diplomatic or military conflict
between the U.S. and Iran that results in an oil-supply shock;
or a trade war between the U.S. and China that escalates into a
larger geopolitical conflict.

But Trump is not the only global risk. China has resorted to a
fresh round of credit-fueled fixed investment to stabilize its
growth rate. That means it will have to deal with more toxic
assets, debt, leverage, and overcapacity in the medium term.
And because growth and economic stability will top the agenda
at the Chinese Communist Party’s National Congress later this
year, discussions about how to rebalance growth and implement
structural reforms will take a back seat. But if China doesn’t
jump-start structural reforms and contain its debt explosion by
next year, the risk of a hard landing will return.

Elsewhere, the recent Dutch and French election results (and
favorable expectations for the German election this September)
have reduced the risk that populists will come to power in
Europe. But the EU and eurozone are still in an economic
slough. And market fears of a disintegrating eurozone will
return if the anti-euro 5 Star Movement comes to power in
Italy’s next election, which could be held early this fall.

In the next year, a more robust and persistent global recovery
will depend largely on whether policy makers avoid mistakes
that could derail it. At least we know where those mistakes are
most likely to be made.

Read: The surprising threat to the
American economy

This article has been published with the permission of
Project SyndicateThe Global Recovery’s Downside
Risks

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