The sharp fall in markets worldwide indicate that rising prices induced by the munificence of central banks can no longer keep going up.
On January 20, markets tumbled from Tokyo and Dubai to London and New York. Three concerns torment investors. First, the slowing Chinese economy terrifies them. The dragon is no longer breathing fire and the global economy is going cold. Second, falling oil prices are a signal that demand is slowing down. Naturally, companies in this sector are suffering and many are in peril. This drives down their share prices in particular and markets in general. Third, many fear that quantitative easing (QE) has reached its limits and this printing of money is damaging the economy. QE was the last weapon that central banks had in their armory and it is no longer working.
Since 2015, this author has been increasingly uneasy about the global economy. The reasons are simple. Central banks have opened their hose pipes and filled the global economy with money. Their hope is that people will spend instead of stash their money in the bank. Companies will borrow and increase production. Increasing consumption and production will lead a virtuous cycle and an uptick in the global economy.
The reality is slightly different. The rich part of the world already has far too much stuff. After all, how many more television sets and sneakers can Americans buy? Chinese factories that have been buzzing away to supply Walmart and Costco are finding that US demand cannot increase incessantly. Most Americans are deep in debt because of student loans, mortgages and credit cards. American consumption can no longer keep Chinese factories busy as in the past. There is a demand problem.
At the same time, there is a supply problem. China has increased production at a spectacular scale. It is the workshop of the world. The scale and speed at which China constructs ports, railways, roads, factories and flats is frightening. Chinese goods are sold all the way from the US and Europe to Africa and India. There are too many Chinese factories churning out too much stuff.
The Chinese economy has reached an inflection point. As a country, China has achieved a transformation that is breathtakingly staggering. As a result, it is deeply vulnerable to market shocks because of its integration with the global economy. Yet its institutions have not kept pace. It responds to new crises using old communist-era tools that simply do not work anymore.
On August 24, 2015, Chinese stock markets suffered “Black Monday” that wiped off trillions of dollars of wealth. The Chinese authorities reacted in panic and tried to catch a falling knife, cutting themselves deeply in the process. China was experiencing what the US experienced in the 1920s. People were incurring debts to play the stock market. When the party stopped in 1929, many were left without their shirts. Luckily for the Chinese, not too many of its citizens were speculating in the stock market. Chinese authorities did not have to prop up the market.
Chinese investors playing the market were the affluent section of their society. If they lost money on the market, so be it. Instead, the Chinese authorities took the money saved by its poor citizens and threw it to those who were rich by trying to keep up share prices. They achieved nothing but shaking confidence in their ability to handle future crises. Even more importantly, they indulged in what the US government engaged in during the bailouts of the big banks: capitalism on the upside and socialism on the downside. Private players gain benefits while tax payers bear the risk and pay the bill.
This transfer of wealth from the poor to the rich has been going on for a while in China. Those with good guanxi get loans from state-owned banks to build apartments or factories. The money in these banks comes from deposits of millions of workers, teachers and other ordinary folks. This money is invested terribly and bad debts in China run into trillions of dollars.
Oil prices are falling in no small part due to the decline in Chinese demand. Commodity prices are falling for the same reason. Countries like Brazil, Chile, South Africa and Australia are suffering as a result. In 2015, this author predicted that the Chinese slowdown would lead to declining, trade, growth and returns to capital. That is coming to pass. Something else that is occurring is the flight of Chinese capital for safe havens, which demonstrates the plunging confidence in the economy of the Middle Kingdom.
Falling oil prices reveal that supply exceeds demand. With sanctions on Iran ending, there is even more oil sloshing around. Oil provides a large chunk of the world’s energy, particularly for transportation. Falling prices put pressure on companies in this sector. In 2015, 39 oil field service companies went bankrupt. Many others will turn off drilling rigs and shut down oil wells. Panic and fear have now replaced irrational exuberance in the oil sector. This sentiment is affecting the market as a whole in a classic example of what John Maynard Keynes once called “animal spirits.”
It is these animal spirits that central banks have tried to stimulate for the last few years. Instead, increased money in the economy has only led to rising asset prices, whether of property or shares. A bubble has been brewing in many parts of the world, but the real economy has not become dramatically more productive or increased human welfare. Bill Gross, a legendary investor who once headed PIMCO and now runs Janus Capital Group, has been damning in his assessment of central banks and the economy.
Gross points out that even if central banks lower interest rates, people may just keep money in cash instead of invest in a security that might lose value. In a brutally candid article dated January 7, this billionaire almost manages to sound Marxist. He compares the Romans giving their Plebian citizens a day at the Coliseum to developed economies providing “Fantasy Sports, cellphone game apps, sexting, and fast food to appease the masses.” He goes on to write: “Keep them occupied and distracted at all costs before they recognize that half of the US population doesn’t go to work in the morning and that their real wages after conservatively calculated inflation have barely budged since the mid 1980’s.”
Even as markets stumble, 14 million people in southern Africa are facing hunger because last year’s harvest was damaged by El Nino. Many believe Ethiopia’s drought to be “as bad for children as Syria’s war.” More than 10 million people need food aid and 400,000 children suffer malnutrition.
Finally, the Zika virus is causing alarm in South America. The World Health Organization estimates that the virus is likely to spread across the Americas. It leads to below-average head size and a smaller than average brain size in children born to mothers suffering from the virus.
A new economic system that has space for tackling long-term problems such as the Zika virus and hunger is the need of the hour. Life is more than stuff and markets cannot be all.
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The US Election Year Foreign Policy Spectacular
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