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What could go wrong with the economy in 2014

Rick Newman
The Exchange
Source: Thinkstock

You have to go back nearly a decade, to 2005, to rediscover a time when the forthcoming year looked as if it would be a prosperous one. Little did most people know back then that a steroidal housing boom would peak in 2006 and enter a savage, six-year bust, followed by a financial panic and the worst economic downturn since the 1930s.

Forecasters are once again cautiously optimistic about the next 12 months. “All in all, the outlook appears balanced and better,” economists at Bank of America Merrill Lynch wrote in a recent preview of 2014. “For the first time in several years, we approach the new year with no major cloud on the horizon.”

A lot, for once, seems to be going right, or at least not going wrong. U.S. employers are slowly but consistently adding jobs, housing is picking up, Europe’s debt woes finally seem contained, the stock market has soared and there’s even a budget deal of sorts in the madhouse known as Washington, D.C. There’s still too much debt in the global economy, and other wounds need to heal, but the stage seems set for calm markets and modest growth in 2014.

The most dangerous risks are the ones nobody foresees, however, which could make complacency the biggest enemy of all in 2014. Here are a few things that could go wrong during the next 12 months:

A fumbled “policy handoff” in Washington. Depending on what happens with the economy going forward, the Federal Reserve will likely continue to wind down the huge bond-buying program known as quantitative easing, which it recently pared back by $10 billion, to $75 billion in bond purchases a month. What’s harder to prepare for is a double-whammy that could occur if the Fed is reducing its aid to the economy at the same time that another smackdown erupts in Congress over the federal borrowing limit (which could happen as early as March) or there’s some other shock to the economy. “Exogenous shocks have a much bigger impact if they happen while you’re tightening monetary policy,” says Peter Fisher of investing firm BlackRock. “You don't notice it as much as when monetary conditions are easing.”

Investors lose confidence in central banks. As in, REALLY lose confidence, rather than just wondering if risky quantitative easing policies in the United States, Europe and Japan will help stimulate growth and create jobs, as intended. If global QE flops, the most likely consequence would be rising interest rates, which would exacerbate public debt problems in all three regions and perhaps force politicians to raise taxes or take other unpopular steps. The biggest risk may be an excessive comfort level with QE, which could turn out to be far less benign than investors have begun to believe.

Hostilities in Asia. China and Japan, traditional rivals, are jostling over a strip of uninhabited islands in the East China Sea, along with the fishing rights, energy reserves and strategic positioning that go with them. China’s declaration of a new “air-defense identification zone” in November escalated the dispute, with both the United States and Japan recently challenging China’s claim of sovereignty over the airspace. In North Korea, meanwhile, the recent execution of a high-level apparatchik seems to indicate doughboy leader Kim Jong Un feels a new level of confidence — or is it insecurity? If he’s acting out because he feels threatened, it could presage more skullduggery in a regime that’s either surprisingly stable or alarmingly brittle.

These Asian powers, plus South Korea, have jabbed at each other for years, while mostly avoiding outright hostilities. And peace is in everybody’s interest. But if rising nationalism in any or all of these countries leads to a fight, markets will quake, and trade between many of the world’s largest economies will be disrupted.

The usual Middle East meltdown. The danger of an oil shock that could arise from Middle East turmoil is a perennial risk, with a few new wrinkles to add to the usual scenarios. The ongoing civil war in Syria hasn’t affected oil prices so far, but it has turned into a kind of proxy war between Saudi Arabia, which backs several rebel groups, and Iran, which supports Syrian President Bashar al-Assad. What will happen if the rebels win?

The potential rapprochement between Iran and the United States, meanwhile, could alienate Saudi Arabia, which is fighting a long cold war with Iran for dominance in the region. This sort of intrigue in the Middle East is nothing new, of course. But it would rattle markets if it caused instability in Saudi Arabia or other big oil-producing nations.

An unforeseen new bust in Europe. There seems to be a real-estate bubble in Sweden, believe it or not. After all the bursting bubbles of the past five years, one more, in an economy as small as Sweden’s (GPD: about $525 billion, or 3% the size of the U.S. economy) probably seems inconsequential. But small events can sometimes trigger much bigger ones — especially if nobody’s expecting trouble--and it's always possible some pebble of a problem will set off another financial slide in Greece, Italy, Spain or other overindebted nations.

Twelve months from now, we might look back on a blessedly unremarkable year in which most parts of the economy got better and nothing terrible happened. It does happen every now and then. The unmistakable lesson of modern times, however, is: Don’t count on it.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.