UK, Italy and China are 3 big economic powder kegs

It is all too common for the global economy to be confronted with a variety of risks. However, as we approach 2019, there would seem to be two qualitative and disturbing differences in the risks now besetting the global economic recovery.

The first is that there is a higher-than-usual chance that at least some of these risks might materialize. The second is that if any of these risks do materialize, they will do more than the normal degree of harm that such risks generally do.

{mosads}Among those risks that have a high chance of materializing next year and that could cause serious global economic damage is an intensification of the Italian sovereign debt crisis.

This has to be of concern for both the European and global economies considering that Italy is the eurozone’s third-largest economy and is approximately 10-times the size of the Greek economy.

It is also of concern considering that the Italian government debt market is the world’s third-largest sovereign debt market and that a considerable proportion of the $2.5 trillion of that debt is held by Italian and other European banks.

Another reason for fearing that an Italian debt crisis might have spillover effects to the rest of the global economy and its financial system is that, unlike was the case in the earlier Greek crisis, Italy might prove very difficult for its European partners to save.

It is not simply that very large sums of money would be involved in saving a country of Italy’s size and indebtedness. Rather, it is that it will be difficult to muster political support, especially in Germany, to spend very large sums to stabilize a country whose government is willfully flouting the eurozone’s rules. 

At a time when Europe would like Italy’s budget deficit to be below 1 percent of GDP, the Italian government is insisting on a draft 2019 budget that would have a deficit closer to 3 percent of GDP.

Another and more immediate risk to the global economic recovery could be that of the United Kingdom crashing out of Europe without a Brexit deal by the end of March 2019 when the two-year negotiating period under Article 50 of the Treaty of Lisbon comes to an end.

Were that to occur, intra-European trade flows would likely be disrupted and European investor confidence would be seriously dented. Moreover, there could be problems in the European capital market stemming from setbacks to London.

A reason for fearing that the U.K. could crash out of Europe without a deal, or at the very least be forced into an early and contentious general election, is that Prime Minister Theresa May does not seem to have the votes to secure parliamentary approval for her Brexit deal next month.

With a revolt now under way in her party’s back benches and with her Northern Ireland junior coalition partner firmly opposed to her Brexit deal, the last doubtful straw at which she may clutch is support from the opposition Labor Party.

However, it does not seem to help her cause that Labor Party leader Jeremy Corbyn appears to be smelling blood, insisting that he could have negotiated a better Brexit deal than did May.  

On a longer fuse, but certainly no less of a threat to the global economic recovery than that coming from Italy and the United Kingdom, would be an economic slowdown in China, the world’s second-largest economy.

Were that to occur, it would have serious ramifications for the rest of the emerging market economies. This is especially the case considering that China is the world’s largest consumer of international commodities.

Heightening the chances that the Chinese economy will indeed slow down over the next year is the likelihood that there will be an appreciable escalation in the U.S.-China trade war.

{mossecondads}It would seem from repeated statements by Vice President Mike Pence that the U.S. now views China more as a serious geopolitical rival rather than as a cooperative trade partner. This could very well lead to President Trump delivering on his threat to substantially ramp up protection against Chinese imports at the start of the year.

Hopefully, none of the risks mentioned above will materialize. However, it would seem to be irresponsible for the Trump administration to premise its economic policy on the assumption that it will be smooth sailing for the global economy next year.

Rather, the responsible thing to do would be to hope for the best but to plan for the worst and to start mending fences with our economic partners whose help might be needed to contain an international economic crisis.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.