With the on-going eurozone financial crisis, a stuttering recovery in the US and fears of a slowdown in economic growth in China, who will be able to rescue the world’s economy if all of the major economies suffer a simultaneous crisis?
A research report from the International Monetary Fund (IMF) released in June 2012 concluded that markets in advanced and emerging economies are more deeply interlinked than in 2008.The report also says that contagion risks are rising and that a shock from one region could have effects worldwide that are even more profound than in the 2008 financial crisis. Min Zhu, the IMF’s deputy managing director, says “the world is much, much more interconnected than at any time before.”
According to Zhu, the equity market linkage between the United States and Asia is currently 81% compared to 42% in 2003 and the impact of an external shock on industrial output has risen from 30% to 40%. The IMF's report also expressed concern that debt levels remain high in advanced economies and warned that the governments have little, if any, fiscal or monetary policy left to combat another crisis. The interconnected global economy threatens to overwhelm risk management. This means the growing risk of a synchronised global economic slowdown may require a coordinated global response.
China, the US, Japan and Europe make up 70% of the world’s economy. China is the largest source of growth in global demand and its economy has slowed sharply. China's manufacturing sector weakened in April, hurt by the recession in the EU. The EU is China's largest trading partner. It faces substantial financial market disturbances, significant political uncertainty and will likely experience deeper than expected recession.
The US saw its export sales to the EU and China fall sharply in April. Since the start of 2012, US economic data showed signs that the economy was resilient despite pressures from the EU and slowdown in China. Recent weak US job growth however suggests that the recovery may be threatened and unable to decouple from the EU debt crisis or slowing growth in China. The US recovery is modest and fragile, which makes it vulnerable to external shocks and continued weakness and major export markets in Europe and China.
Although Japan's economy is expected to grow by 2% this year due to reconstruction from the March 2011 earthquake and a rebound in private consumption, the nation is faced with mountain of debt and a strong yen hurting export sales.
G7 officials held an emergency conference call at the start of June which was followed by a surprise immediate 25 basis point rate cut from China. The rate cut from China generated speculation the central banks and governments of the G7 are about to embark on a coordinated effort to stave off the risk of contagion from the EU crisis and to boost global growth. A number of analysts have suggested that, because economies are so tightly interconnected, governments, companies, industry and central banks will soon be forced to cooperate in ways that could not have been imagined just a few years ago.
The main take away for trading the forex market is that troubles facing the EU will continue to impact risk appetite and likely boost safe haven demand for the USD and yen. If China's economy continues to slow, it will hurt growth in Asia and could spark selling pressure in the AUD because Australia is highly dependent on exports to that region. With trade and investment flow so interconnected, nations highly dependent on exports like Japan and China will want to see their currencies weaken to boost sales. A coordinated central bank response to the deceleration in global demand could spark a major USD decline and sharp rise in gold.
Zoe is London branch manager for easy-forex.com, having previously worked as a forex dealer at CMC Markets and World First. She now provides UK clients with market information, training and seminars.
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