Assume the brace position, we're in for a bumpy ride

Last year was noteworthy for all the things that could have gone wrong but did not: a dreaded "double dip" recession was averted; the situation in Iraq stabilised somewhat; and Wall Street recovered from the panic of late 2008 to deliver some of its best stock market returns in years. Perhaps this year will also conclude on the positive side of the ledger, though this column is not overly confident.

Three negatives in particular are likely to define the next 12-month stretch, with consequences that could extend well into next year and beyond: Sino-American estrangement and a global trade war; a conflict in the Middle East over Iran; and the spectre of rising inflation. The Washington Post rang in the new year with news of a proposed US sale of weapons to Taiwan and a meeting between Barack Obama, the US president, and the Dalai Lama. For those unfamiliar with China's diplomatic irritations, this is the equivalent of the US government spitting into Beijing's sharks-fin soup.

They are minor annoyances, however, compared with what is looming on the horizon. It so happens that this is a year of mid-term elections in America. With jobless rates expected to remain painfully high despite a steadily improving economy, US-China ties will become the preferred target. By mid-year, candidates will be revving up their campaigns with demands that Beijing revalue its artificially weak currency, which makes Chinese goods cheap in the US and American products expensive in China.

Beijing will push back, for several reasons. First, no government likes being told what to do. Second, exporters remain a powerful constituency in China, despite the fact that their revenues account for only a modest share of total economic output, which owes most of its growth to capital investment. Third, any hint that Beijing may inflate its currency would trigger a flood of foreign capital into an economy that is already flirting with inflation following a huge and effective fiscal stimulus package.

A trade war between the world's two most important economies is therefore likely. Such a row could demolish a fragile global economy and isolate China when it should be assuming a level of responsibility proportionate to its growing clout. Sino-US ties, which have been remarkably stable for the last four decades, will be sorely tested this year. Iran, meanwhile, can expect confrontation with the West over its nuclear ambitions.

Should the UN succeed in imposing sanctions on Iran, despite China's opposition - another source of tension with the US - retaliation from Tehran is all but certain, either against vessels passing through or near Iranian waters, or against western targets in the Middle East, or both. At least the threat of an Israeli attack on Iranian nuclear facilities appears less likely now, or does it? For such an attack to achieve even partial success, Israeli jets would have to fly over Iraq, which is something the US government has said it will not allow.

Yet Israel is likely to believe that even a moderate Iranian government, should it come to power, would be unlikely to dismantle the country's nuclear programme and it is unlikely to sit idly by while Iran puts the finishing touches to a bomb. Israel might well calculate, out of domestic political concerns if nothing else, to attempt an assault and blame the Americans for an unsatisfactory outcome than to do nothing. That, in addition to Iranian adventurism in the region, would be more than enough to send oil prices arcing towards the record levels achieved in 2008.

That leads us to inflation. The US-based financial adviser Morgan Stanley estimates global economic growth for this year at 4 per cent. This is not as good as it looks given the staggering amount of debt the world has heaped upon itself to avoid collapse. There will likely be a steady downgrading of sovereign debt, which means governments will have to print even more money to avoid default. Thus inflation, which has lingered in the shadows since the crisis began, will assert itself.

Last week, an economist at the Federal Reserve warned that even in the US, where the economy remains weak, inflation "may be the next dragon to slay". The process of "qualitative easing", the lifting of interest rates as the global economy recovers, must be carefully calibrated. Should central banks tighten too quickly, the economy will splutter. If they wait too long, inflation proliferates. Subtlety and transparency is the key to a smooth transition, lest trigger-happy speculators attack the bond markets.

Certainly the events this year will be a good for bonds, either as a result of credit tightening to pre-empt inflation or because of a flight to quality in response to a crisis. There is one other certainty about this year: it will not be boring. @Email:[e-mail]