Oil, inflation, sovereign debt and revolution
I'll keep this brief. In the next six weeks we're going to get the collision of three strategic problems in economic policy and the outcome is going to shape not just the global recovery path but in particular the different continental stories.
First, we're in the middle of a mini oil shock. The price of crude oil has risen 15% in three weeks and this after a sustained period of energy inflation and food price inflation. This will now take its toll on growth. Barcap's economics team estimates that if oil rises to $125 and stays there, it's going to knock at least 0.5% off the growth of the developed world (see graph on left).
In the same scenario inflation rises by 2% more than it would have done already (graph on right). (Barclays Global Economics Weekly, 4 March 2011).
So we come to the second strategic problem. Monetary policy. Both the Federal Reserve and the European Central Bank have been making signals recently: the Fed that its policy will remain loose, the ECB that it is about to tighten, raising interest rates to choke off inflation.
A Eurozone interest rate rise will please the the kind of stereotypical mittel-Europeans you still meet who will shop only in Netto and who refuse to carry a credit card.
However it will tank the recoveries, such as they exist, in Europe's periphery.
And that brings us to the third problem: the sovereign debt crisis. As I've reported before, this is building to a climax that will begin at the end of this week, and needs to come to some denouement before the summer. Ireland's new coalition will head to Budapest to try and renegotiate the bailout terms; Portugal's refusenik government will come under pressure to seek a bailout and in Greece they will struggle to hold the line against default. It was under-reported but the general strike in Greece, late February, was pretty strong and wider social unrest is simmering.
The USA doesn't have much more it can do, policy wise, but its palliatives finally seem to be working - fiscal stimulus money and QE are having both domestic and global impact, with the first good news on the jobs front finally coming through.
It's the Eurozone that is in a bind: Barcap's economist refer to it as a "different planet". It is about to face an inflationary spike with a policy regime that is monofocused on inflation - so the ECB will hike rates just to prove it has the guts to do so. This will increase the pressure on peripheral governments to renegotiate the bailout terms, and banks of Germany, Britain and France may finally lose some money in the form of haircuts, repayment delays or even, if it gets chaotic, defaults.
They were already facing problems 2 and 3: problem one simply exacerbates problems 2 and 3.
What you want to avoid at all costs is "problem 4" - some kind of war, revolution or military coup in the Mediterranean, Africa and the Middle East which takes the oil price to $200.
When I say "avoid" of course - these things are difficult to avoid in an age of multilateralist diplomacy, where the most powerful military power in the world has to tread on eggshells - so the global risks are rising.
Wars and revolutions tend to be quite symbiotic: what's going on in Libya gives a foretaste of what you might see if a full-blown democratic revolution broke out in Iran.
If oil goes anywhere above $150 all the policy mechanisms become frayed: rate rises have little effect on inflation but heavily impact growth - meanwhile inflation also impacts on growth and what you probably get is stagflation, as after 1973. So, fingers crossed.