Rising risks of a new world financial crisis

China and India are at risk of a sudden slowdown as there is no precedent for their high growth rates being sustained. This conclusion, reported in today’s Australian newspaper, is the result of an influential Harvard study by President Barack Obama’s former chief economic adviser Larry Summers and his colleague Lant Pritchett.

The study found that periods of rapid growth nearly always revert back to long-term average world growth rates, with the end usually coming suddenly. The chance of China sustaining a growth rate of 9% for another two decades is less than 1 in 100.

These conclusions come at the same time that the Organisation for Economic Co-operation and Development (OECD) has stated that there are rising risks of a new world financial crisis sparked by financial weakness in emerging countries, particularly Indonesia and India. Those same countries have been responsible for the vast majority of global economic growth since the global financial crisis, but currently have large external deficits.

Since May, the OECD has lowered its estimate for 2014 growth for the developing world from 6.2% to 5.3%, but the latest commentary highlights a concern about that figure being attainable.

Obviously this has implications for all advanced economies, including Australia. The rise of emerging economies over the past decade has transformed the Australian economy by generating vast demand for resources and driving rapid growth in world trade.

Foolish takeaway

The CIA closely monitors internet chatter to avert terrorist strikes. Similarly there has been increasing economic assessments by leading organisations and market pundits, voicing concerns over world growth. Additionally, the growth risks inherent in potential deflationary forces worldwide have been constantly referred to in recent weeks.

Let us not pretend that an exact turning point can be predicted, however with many leading indices in the developed world at all-time highs, there may be pause for thought given world growth prospects. This would impact mining companies such as Rio Tinto (ASX: RIO), BHP Billiton (ASX: BHP) and Fortescue Metals Group  (ASX: FMG).

It’s just as important to periodically assess why one should hold a stock as it is to make the initial purchasing decision. If one views a decline in world growth as imminent and leading to a negative impact on iron ore prices, then Fortescue would be in the weakest position given its high debt levels.

Alternatively, Fortescue would be the preferred holding should such projected impacts be a year or more away. This is based on my prior assessment that it is starting to overcome some reservations about its debt levels, costs and less than conservative forecasts of prior years.

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Motley Fool contributor Mark Woodruff does not own shares in any of the companies mentioned in this article.

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