THERE have been some scary developments in the world economy in recent days, led by the fallout from Colonel Gaddafi’s horrifying crackdown in the Middle East. Here are five trends that worry me.
1) Libya’s civil war has already doubled the risk premium on oil prices to $10 per barrel, with more to come. But the real threat to prices is if anti-regime protests spread to Saudi Arabia, where demonstrations are already planned, forcing the King to make an urgent return. There would be no problem if a liberal, democratic regime were to spring up – but what if extremists gain power, cutting off oil supplies? After years of costly and depressing post 9/11 military interventionism, Western foreign policy is in disarray. We don’t have a clue what to do next. It would be a horrible end to a revolution inspired by hope if more nations slipped into extremism – and were to push up the price of oil to $150, $200 or even higher in extreme scenarios. What would Barack Obama do if maniacs started torching Saudi wells? Would China, which is equally dependent on oil, step in militarily?
2) Oil importing nations could cope with a further 30 per cent hike in oil prices – but not with 100 or 150 per cent rises. Some would suffer double-dip recessions, putting further unbearable strains on public finances, triggering fresh financial crises and further undermining support for capitalism. With a bit of luck, oil supplies will be all right – but the rocketing price of oil is now the number one risk to the global economy.
3) Oil could derail British politics in another way. If prices keep rising, motorists will turn on the coalition: as Andrew Lilico of Europe Economics points out, fuel duty has jumped a scandalous 17 per cent since December 2008, reaching 58.95p per litre. Truckers could blockade roads again, disrupting supply chains; any settlement which looked as if George Osborne were going soft on the deficit would be received very badly by the markets, which would push up borrowing costs and compound his woes.
4) The Middle East isn’t our only problem. China has hiked its bank deposit reserve requirements twice this year as it battles bubbles. Base rates are below the rate of inflation, which means people are being paid to borrow (if that sounds familiar, it is because the same is true in the UK). The one-year benchmark rate is 3.0 per cent, below the (official) 4.9 per cent inflation rate. The world is relying on China for growth; if it falters, trouble looms.
5) Yields on US junk bonds recently hit a record low of 6.8 per cent, less even than the 6.81 per cent in December 2004. Risk is again massively under-priced, a sure sign of excessive liquidity. Low yields on other assets – caused by central banks – have encouraged investors to pour into junk bonds, pushing prices up and yields down. It’s not all bad: junk still pays 4.56 per cent more than Treasuries, up from the mad 2.41 per cent seen in June 2007. But even then both rates are too low and the gap too narrow. One of the biggest problems in the global economy is that credit – including that being offered to the US government – is too cheap. Eventually, its cost will rise again, trashing equities and other assets in the process.
The most likely scenario is that we will be fine, for now at least. But while pundits are never short of imaginary risks, the harm caused by these forces could yet end up being all too real.
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