Nouriel Roubini sees clouds over 2021
Despite the declines and disruptions due to new variants of COVID-19, 2021 has turned out to be a relatively positive year for economies and markets in most parts of the world. Growth exceeded its potential after the severe recession of 2020, and financial markets have recovered vigorously. This has been particularly the case in the United States, where stock markets have reached new highs, in part due to the ultra-accommodative monetary policy of the US Federal Reserve (although central banks of other advanced economies have continued their their own radically accommodating policies).
But 2022 could be more difficult. The pandemic is not over. Omicron may not be as virulent as previous variants – especially in highly vaccinated advanced economies – but it’s much more contagious, meaning hospitalizations and deaths will remain high. The resulting uncertainty and risk aversion will suppress demand and exacerbate supply chain bottlenecks.
Combined with excess savings, pent-up demand, and accommodating monetary and fiscal policies, these bottlenecks fueled inflation in 2021. Many central bankers who insisted the inflationary surge was transitory now have admitted that she would persist. With varying degrees of urgency, they plan to phase out unconventional monetary policies such as quantitative easing, so that they can begin to normalize interest rates.
The resolve of central banks will be tested if policy rate hikes cause shocks to bond, credit and equity markets. With such a massive build-up of private and public debt, markets might not be able to digest higher borrowing costs. In a crisis, central banks would find themselves in the debt trap and likely turn around. This would make inflation expectations likely to change upward as inflation becomes rampant.
The coming year also brings growing geopolitical and systemic risks. On the geopolitical level, three major threats must be watched.
First, Russia is preparing to invade Ukraine, and it remains to be seen whether negotiations on a new regional security regime can prevent the threat from escalating. Although US President Joe Biden has pledged more military aid to Ukraine and threatened tougher sanctions against Russia, he has also made it clear that the United States will not intervene directly to defend Ukraine against a attack. But the Russian economy has become more resistant to sanctions than in the past, so such threats cannot deter Russian President Vladimir Putin. After all, some Western sanctions – like a move to block the Nord Stream 2 pipeline – could even exacerbate Europe’s own energy shortages.
Second, the Sino-US cold war is cooling off. China is increasing its military pressure on Taiwan and the South China Sea (where many territorial disputes are brewing), and the wider decoupling between the Chinese and American economies is accelerating. This development will have stagflationary consequences over time.
Third, Iran is now a nuclear state on the threshold. He quickly enriched uranium to near-military content, and negotiations on a new or revamped nuclear deal came to naught. As a result, Israel is openly considering strikes against Iranian nuclear facilities. If that happened, the consequences of stagflation would likely be worse than the oil-related geopolitical shocks of 1973 and 1979.
The new year also brings several systemic concerns. In 2021, heat waves, fires, droughts, hurricanes, floods, typhoons and other disasters have laid bare the real implications of climate change. The COP26 climate summit in Glasgow offered mostly low-cost talks, leaving the world on track to experience a devastating 3 Â° Celsius warming in this century. Droughts are already causing dangerous increases in food prices, and the effects of climate change will continue to worsen.
To make matters worse, the aggressive push to decarbonize the economy leads to underinvestment in fossil fuel capacity before there is a sufficient supply of renewable energy. This dynamic will generate much higher energy prices over time. In addition, the flow of climate refugees to the United States, Europe and other advanced economies will increase just as these countries close their borders.
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