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The Great Uncertainty.
Thursday, 5th January 2012
Source : Rabobank

The US subprime crisis marked the beginning of a period we would call the Great Uncertainty; since the summer of 2007, the global economy has been rolling from one crisis to another.

The lesson we can draw is that the world has become a much more unstable and uncertain place. Our base case scenario is that the post-crisis recovery will be bumpy, below-par and brittle until the deleveraging process comes to an end.

Meanwhile, the global economy continues to face major risks that can potentially knock it off course. The six most important known unknowns are discussed in six separate Special Reports. Below, we will give you an overview of all six risks with our brief conclusions.

1. Risk of a complete breakup of the eurozone
Pushing the periphery to carry out a cocktail of reforms and austerity measures may not be sufficient to restore market trust. In our view, once European leaders truly begin to stare into the abyss, they will do ‘whatever it takes’ to resolve this crisis. This is far less costly than the alternative.

2. Risk of sovereign debt crises in the US and Japan
Borrowing costs in Japan and the US remains very low. The danger is if these two countries begin to feel ‘market-proof’. Without more ambitious fiscal consolidation, a sovereign debt crisis remains a distinct possibility.

3. Risk of financial repression in the West
One cannot help noting that one of the by-products of the design principle of the current financial regulatory framework is to make it easier to work down the massive public debt overhang. If such muzzling of the financial sector leads to full-scale financial repression, then potential growth in the global economy will drop at the worst possible time. We hope that policymakers will stay clear of such policies.
4. Risk of hard landing in China
We see the soft landing scenario as the most likely for 2012. However, the financial sector has weakened as a result of strong credit growth and is particularly vulnerable in light of the increased headwinds. With external demand slowing as well, a soft landing scenario is becoming more and more dependent on strong growth-supporting policies. If the Chinese authorities fail in their efforts, a hard landing scenario could materialise after all.
5. Risk of sudden reversal of capital flows from the emerging markets
The risk of an outright, massive reversal of foreign capital flows is rather limited, although not impossible. A comforting factor is that many EMs have room to spare to stimulate their economies. Unfortunately, this doesn’t hold for all EMs.

6. Risk of de-globalisation
We see protectionism rearing its ugly head around the globe. After the initial exchange of fire started with the currency wars, nations are increasingly moving towards total economic warfare. Should policy makers in Europe finally be able to work together in order to get the economic house in order, that may send a strong signal to the rest of the world that cooperation by far outweighs navel-gazing.

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