The world economy in 2008 will probably avoid a recession, thanks to growth in China and other emerging markets. The subprime mortgage crisis will prompt a severe slowdown which could dip into recession in the U.S. This will slow growth in the UK, EU and Japan, but these areas will avoid recession, thanks to increased trade with the rest of the world.

The biggest risk is the eventual fallout from the mispricing of new financial instruments, such as Asset-Backed Commercial Paper. Ongoing foreclosures and credit defaults mean that investors are holding assets of unknown value. So far, mainly banks and hedge funds have been affected. However, municipalities, corporations and individual investors have also bought these products. The greatest risk is that the extent of the effects of the subprime mortgage crisis is unknown.

Other risks to the 2008 world economy

• Stagflation - The new financial products increased global liquidity, which itself is causing inflation. A declining dollar has forced oil-producing nations to raise the price of oil. If prices stay high, while the global economy slows, central banks will be at cross-purposes. This has already happened, where the U.S. is lowering interest rates to avoid a recession, while the ECB is keeping rates high to fight inflation.

• U.S. current account deficit - The deficit prevents the U.S government from cutting taxes, which would boost the economy.

• U.S. election - There is no favorite right now, and the politics of the candidates are diverse. This creates uncertainty, as well as the increased risk of protectionism.

• Kosovo independence - Kosovo's recognition as an independent country could set a precedent for other small provinces, such as Northern Cyprus, Palestine, and provinces in Russia and Spain, to declare independence. This could have a destabilizing effect on the global economy.

What it means:
The global economy is generally stronger than it has ever been. Countries continue to learn how to better manage their economies to cut back on painful boom and bust cycles. However, it is also more inter-related, money is moving faster, and new financial products are so innovative that they are poorly understood.

The global economy should avoid a recession, unless something unpredictable happens. And the chances of that are fairly high. The correction in the global stock markets and credit markets may seriously escalate into something worse before it gets better. Hopefully, you have already moved any money you need in the short-term to a money market account.

The best way to withstand market volatility is with a well-diversified portfolio.



Source: Money Watch