If We Have A Lehman Moment The West Must Share Blame With China
Even the state-run media called it “Black Monday”. The Shanghai Composite, China’s main share index, plunged an eye-popping 8.5pc in a single day at the start of last week. Tuesday saw another 7.6pc drop.
These dramatic falls, which followed a more gradual but still stomach-churning 11.5pc decline in Chinese stocks the week before, ripped through global markets. America’s Dow Jones Industrial Average share index plummeted an unprecedented 1,000 points, before closing 588 down – its biggest decline for four years. The FTSE-100 endured a 4.7pc nosedive, its worst one-day loss since 2009. Germany’s Dax index, also, went into “bear market” territory, falling to more than 20pc below its peak. Commodity prices similarly plunged, with oil hurtling down towards $40 a barrel, testing six-year lows.
Such market gyrations have, more than at any time since the Lehman Brothers collapse in September 2008, raised fears of a renewed financial crisis, with all the related economic, political – and human – fall-out. Yes, trading in August is thin, and artificially low volumes can cause sharp price movements. Western markets have also since bounced back, with stocks across the UK and America, by last Friday, having recovered most of their losses.
This end-of-week surge only happened, though, due to drastic and ultimately unsustainable measures taken by both Chinese and Western policymakers. While cutting interest rates for the fifth time in nine months, Beijing also tightened rules on short-selling, banned large shareholders from offloading stakes and forced local pension funds into domestic stocks. Despite such strong-arm tactics, or perhaps because of them, the Shanghai Composite, at the time of writing, remains significantly down on last weekend.
The reversal on Western markets, meanwhile, was largely driven by a senior Federal Reserve official hinting that an interest rate rise, previously signalled for September, has become “less compelling” in light of renewed financial volatility. A similar sentiment has spread to the UK, of course, with investors now betting the Bank of England won’t raise rates until October 2016 – six months later than expected just a few weeks ago. There’s also widespread speculation, which the Fed isn’t discouraging, that America will soon engage in yet another round of quantitative easing – so-called QE4.
Stocks have, indeed, partially recovered from the nerve-gangling falls seen last week. The headlines have improved and the acrid smell of financial fear abated. But that’s only because Beijing has used heavy-handed stake diktat, utterly incompatible with the normal operation of financial markets. The Western world is similarly engaging in gross market distortion, albeit of a different kind – by keeping real interest rates firmly in negative territory and, once again, stoking shares with the promise of further hundreds of billions of dollars of virtually printed money.
This China crisis is, on the surface, all about China. Having grown 9.8pc a year since the late-1970s, the economy of the People’s Republic now outstrips that of America on a purchasing power parity basis (adjusted for living standards). In recent months, growth has slowed – with official forecasts now pointing to a 6-7pc expansion in 2015 and some analysts questioning the veracity of government statistics.
The Chinese economy is, by recent standards, going through a bad patch. With the big Western economies still shaky, export demand fell 8.3pc in July. Growth in industrial production, fixed-asset investment and retail sales all slowed last month. The stock market remains some 40pc down since June – and China’s banks, after years of over-investment in projects driven by political rather than economic logic, have a surfeit of non-performing loans smouldering on their balance sheets.
Having said that, China’s property market, which drives domestic economic sentiment to a greater extent than equities, and underpins the banking sector, remains pretty buoyant. Despite slowing in July, industrial output still rose 6pc with retail sales no less than 10.5pc up. While exports are flagging, it is China’s retail and service sector that must grow if the economy is to mature and re-balance. And while stocks are down, shares remain some 40pc up on January 2014.
Beijing is meanwhile sitting on over $3,700bn of foreign exchange reserves – by far the world’s biggest haul. And despite recent cuts, Chinese rates are still 4.6pc, giving the People’s Bank of China room, if needs be, for further reductions.
In recent weeks, and particularly since last Monday, a narrative has emerged that global financial markets could now crash, but if they do, then it will be the fault of the rest of the world – and, in particular, China. If only those pesky emerging markets could run themselves properly, goes the Western narrative, then we wouldn’t have to endure the market volatility caused by their bad decisions.
Such analysis, while perhaps comforting to policymakers in London, Washington and elsewhere, doesn’t stack up. In 1998, an emerging markets crisis – starting in Thailand, then spreading across Asia to Russia – was indeed the catalyst for a significant downturn on global markets. The collapse derived from chronic private and public sector indebtedness across such countries, many of which were in the throes of emerging from years of economic isolation.
The 2008 sub-prime meltdown, though, was made almost entirely in the West. It was our banking sector and our lack of decent financial regulation, particularly in the US and UK, which sparked the deep dive on global markets. And, since that crisis, it has been the West’s failure to stage a meaningful economic recovery, despite massive monetary and fiscal stimulus, that has prevented the broader global economy from firing on all cylinders.
The emerging markets are now far stronger than in the late 1990s – between them holding no less than 75pc of all global currency reserves. They are, in general, far less indebted and far more likely to be running trade surpluses, than their Western counterparts. If we are on the brink of another “Lehman moment”, than it is the West’s response to the sub-prime crisis – above all, our continued reliance on growing debt and monetary stimulus – that must take a large share of the blame.
These latest market squalls do date from China’s move to encourage the depreciation of the yuan. But there have been numerous other tremors in recent months and years emanating from the Western world, not least those related to the Fed’s tortured “definitely, maybe” musings on raising interest rates – its reluctance due to fears that even a single rate rise risks crashing our bloated financial assets. Then there’s the dark shadow that’s long been cast over global markets by the potential unravelling of the grossly incoherent grand project that is Europe’s single currency.
Let us also ask ourselves, honestly if we dare, why Beijing moved to lower its currency? In part, to demonstrate to the International Monetary Fund enough “currency flexibility” that Washington might deign to allow the yuan to be included in the official reserve currency basket. Of course it should – and, given the size of China’s economy, it’s absurd the yuan has, for so long, been excluded.
The main reason, though, is that since the 2008 financial crisis, the yuan has appreciated by some 40pc on a trade-weighted basis, prior to Beijing’s move, as the likes of the US and UK, and more recently the Eurozone, have engaged in turbo-charged QE – with the Fed and the Bank of England expanding their balance sheets by a colossal 4.5-times and 6-times respectively.
Now, faced with tumbling exports, China is finally responding and, across the Western world, reality is hitting home. Asset price bubbles blown up by money-printing and negative real interest rates eventually go bang. And that has very little to do with China.
Follow Liam on Twitter @liamhalligan