Is the world in fact a riskier place? Many believe so, and our team here at EDC often debates the issue. Daily we are inundated with negative news ranging from impending trade wars to yet another climate-change-driven natural disaster. How are we to make sense of it all?
The go-to indicator for many investors has often been the VIX index, which measures market expectations of near-term volatility. Its latest reading is up 19 per cent from this time last year. Other traditional volatility measures, such as gold prices, have not shown large movements. However, many of the risks presented below, while still considered tail risks (low probability/high impact), are increasing in likelihood and could well become base case scenarios.
1. Fortress America
Our top risk remains Fortress America. Whereas last year the talk was all about the possibility of the US imposing a border adjustment tax, there is increasing concern about the future of NAFTA and what a materially renegotiated agreement or even a US withdrawal would mean for Canada.
2. Global protectionism
Closely connected is the worry that US actions won’t stay contained but will spread internationally: the growing risk of Global Protectionism. The recent announcement of tariffs on aluminum and steel imports threatens to spark retaliatory actions – a key threat to world growth just as it’s building momentum. Although the newly-signed Comprehensive and Progressive. Agreement for Trans-Pacific Partnership counters this risk, the structure of international trade is still being challenged.
3. Global recession
Newcomer-Global recession: Unlike the first two risks, which are being driven by a wave of anti-trade sentiment, it is unclear what the primary driver of a new recession would be; overleveraged corporations? A collapse in consumer confidence? One notable difference from the previous financial crisis is that Western governments no longer have the fiscal capacity nor their central bankers the policy room to remedy the situation.
4. Quasi-sovereign default
Easy lending conditions the past several years have allowed state-owned enterprises (SOEs) in emerging markets to accumulate high external debt levels. As rates rise, companies could default on debt and fail to honor amounts outstanding to suppliers. Several state-owned oil companies are particularly vulnerable given their growing debt and the somber outlook for oil prices.
5. Cyber attack against major corporate or public-sector entity
Cyber-theft and economic cyber sabotage used by criminal groups can inflict material damage on a country’s critical infrastructure and/or corporate sector. Canada is not immune to this growing risk; the Bank of Canada has repeatedly warned that cyberattacks could undermine confidence in our financial system.
6. Inter-state war
Although the probability of an Inter-state war remains low, it could provide a major shock to the global economy if it were not contained. As military tensions rise between Russia and the West, most notably over the skies of Syria, the potential for miscalculation and escalation grows.
7. China’s credit/financial crisis
Financial imbalances are on the rise in China - growing debt levels, mostly involving SOEs and local government, are acknowledged and heightened risks. Total outstanding debt now stands at over 250 per cent of GDP. A financial sector crisis due to bad debts would lead to a widespread economic slowdown and reduced demand for Canadian exports.
8. Conflict on the Korean Peninsula
Although the Olympics offered warm images of Korean athletes uniting, and recent diplomatic overtures by the North Korean regime have lowered the temperature and the likelihood of Conflict on the Korean Peninsula in the short-term, this risk remains ever-present and could surge again.
9. Automation + technology = youth unemployment
While this trend of automation and technology upsetting traditional industries is already happening, youth will be disproportionately impacted by these changes. This could have a destabilizing effect on societies, including on domestic politics.
10. Disorderly Brexit
This time last year Europe seemed en route to electing radical parties across the Continent and putting the eurozone in its crosshairs. Instead, the centrists prevailed, and France elected its most pro-EU president in decades. While we remain concerned about a disorderly Brexit, this risk has dropped significantly from last year.
Finally, our honorable mention is a cryptocurrency-induced currency collapse. Given they are unregulated and vulnerable to theft, cryptocurrencies’ rise has the potential to be very disruptive to the global money supply.
The bottom line?
While much has changed in a year, we haven’t significantly altered our top-risks list. This can in part be explained by the fact that structural changes, even if sped up by technology, don’t happen overnight. For Canadian exporters, understanding how these shifts will unfold and the impact they will have, will be key in realizing the opportunities risks undoubtedly create.