[The Editors' Verdict] Three Major Risks for the Global Economy in 2022

Kim Kyung-soo, Professor Emeritus at Sungkyunkwan University

The pandemic shows no signs of abating even after three years. With cumulative confirmed cases surpassing 300 million, new cases continue to break records. Recently, The Economist estimated that although the official death toll is 5.5 million, the actual number could be two to four times higher.

Despite this unfortunate situation, thanks to vaccines, economic damage has actually decreased even as the pandemic persists. The Omicron variant, expected to impact the global economy at the beginning of the year, is likely to exacerbate supply bottlenecks caused by labor shortages rather than consumer spending, increasing the risk of inflation.

Three risks loom over the global economy in 2022, a pivotal year on the path to the post-pandemic era. First is the aftermath of the ultra-loose monetary policy implemented by the U.S. Federal Reserve (Fed) in response to the pandemic crisis. The minutes of the Federal Open Market Committee (FOMC) meeting last December emphasized the need for tapering (reducing asset purchases), interest rate hikes, and balance sheet reduction. All policy tools to combat inflation were mentioned.

Last week, global stock and bond markets were drenched in fatigue, and the value of the U.S. dollar soared after confirming that the Fed, which had previously prioritized employment over inflation by introducing an average inflation targeting system, has made a 180-degree turn.

Going forward, the Fed is expected to exert full efforts to prevent inflation from spreading by raising nominal wages. This is because if inflation expectations become entrenched, a vicious cycle of "price increase → wage increase → price increase" could occur.

In December, nominal hourly wages increased by 4.7% year-on-year. Considering the pre-pandemic trend of a 3% nominal wage increase, there is already a strong indication that inflation is driving wage growth.

It is difficult to expect the Fed’s monetary policy to be timely in the future. Initially, the Fed overlooked inflation (now unlikely to be ignored) and may accelerate tightening belatedly, risking economic recovery. Above all, as inflation factors exist on both demand and supply sides, it is impossible to control both prices and employment simultaneously.

Stable growth of the Chinese economy, crucial for global economic recovery, is also challenging. The People's Bank of China lowered the reserve requirement ratio at the end of the year. Although this was a response to the rapid cooling of the real estate-related industry, which accounts for 30% of GDP, caused by the Evergrande crisis?the second-largest real estate company?it is important to note that initial leverage regulations on real estate companies triggered this situation. Despite the reserve ratio cut, the 14th largest company, Simao, reportedly defaulted last week.

According to the Bank for International Settlements (BIS), as of the end of June last year, non-financial corporate debt in China was close to 160% of GDP. Debt overhang, where excessive debt constrains growth, is the biggest challenge facing the Chinese economy.

Moreover, with new variants becoming dominant, the "Zero COVID policy," which controls borders and restricts people's economic activities, will inevitably have negative ripple effects on the economy. However, the expected recession-induced current account surplus could lower the global economy’s real interest rates, providing support against downward pressure on U.S. Treasury prices during the Fed’s balance sheet reduction.

Geopolitical risks bring unexpected consequences, as seen when the Kazakhstan protests triggered by a surge in oil prices led to a spike in uranium prices and a crash in Bitcoin. The tests by China, Russia, and Iran on the United States?whose hegemonic status is shaken, symbolized by the withdrawal from Afghanistan?are currently hot issues. Gideon Rachman of the Financial Times (FT) predicted that if these tests materialize, it would mark the end of (U.S.-led) globalization. It is difficult to gauge exactly what this would entail at this time.