The pandemic is largely in the past, but other afflictions are challenging the global economy. Shocks to the supplies of labor, energy, and imports have created uncomfortable levels of inflation. High interest rates, designed to tame the price level, are providing a shock to the financial system. And the potential for geopolitical shocks going into the new year is significant.
The desire for more resilient supply chains and advancing stress between nations are leading to economic decoupling. The use of commerce as a weapon when diplomacy fails is becoming more widespread. The accelerating retreat from globalization will have consequences for trade, inflation, and capital.
Bringing production closer to home will not be easy, and it will be expensive. Some countries may gain from the global reorientation, but most will lose.
Reaching peak inflation, and moving past it, will be critical to economic performance. Failure to achieve containment will invite workers to press for even higher wages, threatening a damaging spiral.
Recognizing this risk, monetary policy has been exceptionally aggressive. Rapid increases in interest rates create another set of risks: to financial stability, and to ongoing expansion. Friction between central banks and their governments is rising with bond yields. Balancing competing objectives and placating restless stakeholders carries a high degree of difficulty for policy makers.
The risk of a downturn is significant in many markets. Soft landings are rare, and none have been achieved after inflation has reached its current levels. If a recession comes, the strength of balance sheets across the economy should make it a relatively short and shallow one for developed markets.
The same cannot be said for some emerging markets. Many have had to raise rates prematurely to defend their currencies, increasing debt service burdens. A slow recovery from the pandemic, along with high fuel and food prices, leaves populations and their governments vulnerable.
International dogma during the past thirty years has stressed deeper commercial ties as a means of keeping the peace. But the threat of sanctions and economic loss have not been enough to prevent heightened aggression. Some very serious scenarios are escalating in likelihood.
The mere threat of geopolitical strife hinders economic and market progress. Should it manifest, the foundations of economies and markets will be severely shaken.
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