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Global Economy 2014: When the Giants Unwind (Andy Xie)

The world has depended on Chinese and American stimulus for years, and one implication of their tightening is a slowing global economy in 2014

by Andy Xie

China and the United States, the primary sources of economic stimulus since 2008, will begin to unwind their stimulus in 2014. The Fed's announcement of its first reduction in quantitative easing and China's rising interbank interest rate are signals of what is to come. The main driver for the unwinding is concerns of bubbles, not that economies are strong enough.

Unwinding stimulus, especially one so large and prolonged, is fraught with unintended consequences. Bubbles tend to pop, not deflate slowly. Even though authorities are calibrating their tightening steps carefully to achieve a smooth landing, financial turmoil due to a bubble bursting is possible, which may drag the global economy into another recession.

Even if no financial turmoil emerges, some assets are likely to come under strong pressure. The economies that depend on commodity exports and/or hot money to plug their current accounts may see their currencies under more pressure. The Australian dollar and Brazilian real are highly vulnerable. The Indian rupee is another weak currency. The Canadian dollar and Russian ruble may come under pressure too.

Continue on for a good read about the global economy.

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Unwinding the global asset bubble... Danger...

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Neither China nor the United States has built a sustainable growth dynamic with stimulus. As the stimulus side effects – bubbles and rising leverage – become the main show unwinding stimulus becomes urgent. This is why both countries are likely to take tightening steps.

Unwinding stimulus is usually a dangerous business. One never knows how much hot air the stimulus has created. When it leaks, it could cause a big explosion. For example, the Fed's tightening cycle in the past usually triggered an emerging market crisis. As the United States itself isn't on a strong growth path, the risk at home is substantial.

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