Loose monetary policies on a global scale will become the root of the world economy's predicament in 2013. Quantitative easing (QE) will probably continue for a long time. Currently, developed countries are almost at the end of their resources. Generally, fiscal policy, monetary policy and industrial policy are the major tools for economic stimulus. Advocates of neo-liberalism such as the United States and Britain do not acknowledge industrial policies. Meanwhile, developed countries are mired in debt troubles and their fiscal policies are limited. Therefore, monetary policy makeovers have become the only means that are repeatedly used for economic stimulus.

In this context, the monetary authorities have automatically become the instructor of the economic fate and even the political fate of the countries. Ruling by finance has partially become true in some countries. The firm attitude of the monetary authorities toward various loose currency policies means only when the real economy returns to the right track, can the policies be terminated. At least before the end of 2013, reducing liquidity stock in the market is not only harmful for economic stability but also against the monetary authorities' judgment on the current economic operation.

The potential exists for an explosive eruption of the negative effects of QE. Currently, there are several major quantitative easing policies that could stir global capital markets, including QE3 and QE4 from the U.S. Federal Reserve, Long-Term Refinancing Operation (LTRO) and Outright Monetary Transactions of the European Central Bank, QE11 of the Japanese central bank and Basel III new liquidity rules. Even if the U.S. Federal Reserve does not increase its QE and the European LTRO fades out gradually, the liquidity stock in the global market will not decline much. What concerns the world economy more is that Basel III has loosened the liquidity requirements of banks, which would free up the liquidity deposited in financial institutions and result in an increase of international commodity prices.

Hotspots and risk points

The competitive devaluation of major currencies led by the U.S. dollar and the cross-border capital management of developing countries could become the hottest financial events in 2013, especially as the political row in the United States continues. The ongoing spat between Democrats and Republicans over the debt ceiling and fiscal deficit shows that political reconciliation in the United States is becoming harder and harder. Deficit reduction could certainly help the U.S. economy become much healthier; however, the fallout from the persistent controversy over deficit cuts often sends U.S. financial markets on a roller coaster ride.

Thus, the United States has taken to pushing currency depreciation as a main approach to surviving the volatile economic situation and promoting its economic competitiveness. And consequently, the flow of hot money between newly emerging economies and the United States has accelerated. For a global financial power like the United States, cash flow and price fluctuation are necessary means for making profits. But emerging economies, which are highly sensitive to exchange rate volatility, will surely be hit. They will have to manage cross-border capital flows to protect themselves and prevent developed countries from shifting their crisis onto them. This measure is likely to pit developed countries and developing countries against each other economically, causing another severe blow to the weak and fragile world economy.

The European debt crisis will continue to be the biggest risk point of the world economy in 2013. Odds are increasing that the vicious cycle of economic and financial crises creating political crises will persist. Generally speaking, the European debt crisis may enter a silent period in the first half year of 2013 as Germany tries to create a peaceful external environment in consideration of its upcoming general election in September this year. To that end, Germany has compromised on issues such as the European Central Bank's role as a possible lender of last resort, the European Stability Mechanism, the European banking union and bailout for Greece.

The adoption of these new agreements has ostensibly brought hope for the settlement of the European debt crisis, but they have laid a huge burden on Germany. Moreover, they are not in line with Germany's economic and political interests. The battle among eurozone countries, therefore, could possibly resurface after the German general election concludes. If the new anti-crisis measures fail on the verge of success, it is possible that structural crises in EU, including the Spanish banking crisis, the Italian political crisis, Greek fiscal problems and youth unemployment, may break out simultaneously—one of the worst situations the world economy could face in 2013.

How will the crisis end? There is still no answer. Historically, economic and financial crises have had a domino effect. For instance, the oil crisis in developed countries in the 1970s was followed by the Latin American debt crisis; and the Southeast Asian financial crisis overshadowed the U.S. banking crisis. Economic and financial crises of developed countries often led to currency crises in developing countries. The ongoing crisis has so far undergone three stages: the U.S. subprime mortgage crisis, the global financial crisis and European sovereign debt crisis. What is unknown is whether it will stop here or spread into a Japanese debt crisis, or a currency crisis for emerging economies.

The author is a researcher with the China Institutes of Contemporary International Relations

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