June 20, 2012 on: Economical

The World Bank Global Economic Prospects Report for June 2012 warns: “Developing countries should prepare for a long period of volatility in the global economy by re-emphasizing medium-term development strategies, while preparing for tougher times.”

Hans Timmer, Director of Development Prospects at The World Bank, goes further in stating: “Developing countries should pre-finance budget deficits, prioritize spending on social safety nets and infrastructure, and stress-test domestic banks.” Andre Burns, Manager of Global Economics at The World Bank, gives this wake-up call: “An escalation of the crisis would spare no-one. Developed- and developing-country growth rates could fall by as much or more than in 2008/09”. I was at a luncheon talk discussing the very successful political and other reforms of a developing country in Asia last week. It was a fascinating talk about how this country has moved so quickly forward in democratization, freeing up the press and the internet, and more. These reforms have moved forward without much violence or stress, excepting some ethnic-based troubles in the northwest of the country. As I listened to this heartwarming story of the growing success of this country I could not help but think of the storms brewing in the EU, in the Middle East and elsewhere, that could put the brakes on the development, both political and economic of many countries. Greece is in very bad economic shape. Spain, Italy, Portugal, and Ireland are also under severe economic stress at many levels. The entire Eurozone could be at risk if Greece decides against following through with its fiscal and other economic reforms. If Greece defaults, it will be a very messy situation. There is lots of talk about a “smooth default”. There is no such thing as a smooth default.  It will be at even greater risk of Greece leaves the Euro and goes to another currency, such as returning to the drachma. If this happens then other countries in the Eurozone will think a lot harder about doing the same. However, one thing holding back such a move may be the extreme measures by groups of central banks in the world to shore up this sinking ship called the Greek economy. Another thing is that the Greeks realize that most of their debt is denominated in Euros or other hard currencies. Their debt costs would sharply increase if they had to pay for them with drachmas. Inflation, unemployment and more will get worse in Greece in most scenarios, unless they can become more politically functional. The economy of Spain is much larger than that of Greece. Italy’s economy is even larger than Spain’s. If Spain and Italy head down a similar road as Greece then the world economy is at even greater risk. The contagion just from Greece could be bad enough. Contagion from increased financial and economic stress in Spain and Italy could really start a serious storm. Many countries, private banks, investors and more own the debt of these countries worldwide.  The interlocking nature of debt within and from the EU globally is astonishing. Global financial markets could get a hit like what happened after the bankruptcies of the major investment and other banks in the US, but maybe even worse. Actually, it is likely to be worse under some scenarios. All of this will affect trade in many parts of the world, not just in the EU. China’s biggest trading partner is not the US. It is the EU. The slowdowns and increased risks in the EU are part of the reason for the slowdown in China. China is Mongolia’s biggest market. If a good part of the EU tanks, an American expression for going badly downhill, then China’s economy will be hit – and possibly hard. The US economy is at risk. The biggest investment partners of the US are the EU countries. Many US investors will lose a lot if the EU tanks. The US trades a lot with EU countries. It also trades a lot with countries that trade a lot with the EU, such as China. Therefore, here is a second mechanism for Mongolia to lose from the EU. The stagnant Japanese economy could also be hurt by reduced demand and the tightening of the world financial markets.  Much of Southeast Asia relies on China as part of their engines of growth. China demands their raw materials, fuels, and intermediate products that China uses to produce the final products that it exports. The EU also has significant trading relations with Russia, another neighbor with Mongolia, but one that is hardly as important as China is for the Mongolian economy. However, if the Russian economy heads south this could also feed into the Mongolian economy’s losses. Another aspect of this is the price of coal. If the EU’s economic plight throws much of the world economy, including the biggest user of coal, China, into slower growth or recession, than in most circumstances the price of coal will go down. This will not be good for Mongolia. The world economy is interlinked in other very complex ways via hedge funds, trillions in foreign exchange transactions per day, potentially quickly moving “hot money” foreign portfolio investments, massive flows of mutual funds and other institutional investment activities and more. This small article can hardly cover them all. Let us just say that Mongolia needs to keep a close eye on the EU and countries connected with it economically and financially to fully understand some of the risks it faces. Mongolia may be very far away physically from Athens, Madrid and Rome, but it is just a keystroke away when it comes to electronic changes that could affect many aspects of economic and financial risk for the country and its region. Oh, yes, then there is all of that talk about an attack on Iran. It will not stop at a series of air attacks. Every military person of any worth would know that. It could escalate to a spreading war in various scenarios. How does $250-350 a barrel of oil sound? What would that do to the EU, China, and the US and to Mongolia?  However, that is another story on how we are all so interconnected. The 2008 recession was a bad one. If the many financial, military and other risks we face get much worse and financial contagion results, then some parts of the world could face an economic dzudh. Let us all hope this does not happen and that world political and financial leaders can finally show us how to handle crises in a complex internationally economy. However, that may require beyond excellent leadership, diplomacy, teamwork and statesmanship.  


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