The coming year is likely to prove to be one of the more challenging years for the global economy. At the very start of the year, there are all too many stresses in the world economy that can be identified even before the U.S. Federal Reserve begins normalizing interest rates. In a world of rising geopolitical risks, one also needs to worry about presently unidentified risks that might emerge as the year progresses.

The most important risk to the global economy has to be associated with the European economic and geopolitical outlook. This is particularly the case considering that Europe accounts for around one quarter of world economic output and that its financial system is deeply intertwined with that of the rest of the world.


As the year starts, Greece appears headed for another major economic and political crisis, the eurozone appears to be on the cusp of Japanese-style price deflation, and both the Russian and the Ukrainian economies appear to be imploding. To compound matters, during the course of the year contentious elections are to be held in the United Kingdom, Spain, Portugal, Finland and Denmark. These elections are all too likely to reveal a further crumbling in European public support for traditional centrist parties as well as for the European project.

The current Greek situation is particularly troubling since by as early as mid-year it could constitute Europe's Lehman Brothers moment. Whatever the outcome of the Jan. 25 parliamentary election, it is difficult to see how Greece can avoid a major policy collision with its European partners. Greece is showing every sign of austerity and economic reform fatigue as its economy remains mired in the deepest of depressions. It is doing so at the very time that its European creditors are increasingly reluctant to provide Greece with additional financing unless it honors its prior budget and economic reform commitments. Sadly, this has all the makings of a full-blown Greek banking crisis once its current International Monetary Fund support program expires at the end of February.

In the event that Greece's current political turmoil results in yet another domestic economic and financial crisis, there is the real risk that this time around Greece's main European partners might choose to cut Greece loose from the euro. Rather than choosing to throw more good money after bad in yet another Greek bailout, Greece's European partners might decide that the time is now propitious to use Greece as an example to other countries in the European periphery as to the consequences of straying from European economic policy orthodoxy. This risks provoking contagion to other highly indebted European countries like Italy, Portugal and Spain. The bank depositors of those countries might very well run on their banks too when they see that the European Central Bank is not always there to bail out euro member countries' bank depositors.

Another major source of world economic risk in 2015 could be the result of large currency movements that could revive fears of a global currency war. In the year ahead, there is every prospect that as the Federal Reserve will abstain from new quantitative easing and will start normalizing interest rates, both the European Central Bank and the Bank of Japan will step up their pace of quantitative easing in an attempt to fend off deflationary forces. These divergent monetary policy trends between the major countries must be expected to propel the U.S. dollar ever higher and to substantially cheapen both the value of the Japanese yen and the euro.

The principal victim of a further strengthening of the U.S. dollar would be the major emerging market economies. According to the Bank for International Settlements, in recent years the corporate sectors of these economies have issued U.S. dollar-denominated debt totaling around $2 trillion. Financial stress in the emerging market countries' corporate sectors as a result of currency mismatches would seem to be the last thing that an already slowing global economy now needs. This is especially the case considering that over the past decade, the emerging market economies have been the main source of global economic growth.

If there is no shortage of identifiable economic risks ahead, the same is certainly true of the geopolitical risks now confronting the global economy. As the United States beats its retreat from the region, rarely has the Middle East looked more unsettled. And as its domestic economy collapses under the weight of economic sanctions and low international oil prices, not since the end of the Cold War has Russia looked more menacing. The last thing that an enfeebled European economy now needs is another bout of Russian adventurism abroad to divert domestic attention away from its rapidly crumbling economy.

One has to hope that in setting monetary policy, the Federal Reserve is mindful of the unusual confluence of major economic and geopolitical risks confronting the global economy. For not only could those risks constitute a significant headwind for the U.S. economic recovery — they could also be triggered by the premature normalization of U.S. interest rate policy.

Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.