Rarely have financial markets had a more traumatic start to the year. Shares plunged, the price of oil clattered to its lowest level in 11 years, trading on the Chinese stock market was halted twice, and the World Bank warned that a “perfect storm” might be brewing.
George Osborne chose his moment well to go public with his concern that the UK faces a “cocktail of threats”. In addition to the $2tn wiped off global stock markets, the North Koreans claimed they had exploded a hydrogen bomb and relations between Saudi Arabia and Iran worsened markedly.
On the face of it, there seems no reason why the global markets should remain depressed. Rising oil prices have traditionally been associated with recessions, so a drop of more than two-thirds in the cost of a barrel of crude should, logically, be good for growth. Cheaper energy means lower costs for businesses and additional spending power for consumers. There are winners and losers from a falling oil price but on balance the impact should be positive.
What’s more, it could be that the gloom about China is overdone. The slowdown in the rate of growth is not just intentional but desirable. Should the economy cool more quickly than planned, Beijing has plenty of power to ensure there is no hard landing: it can boost public spending; it can push the currency lower to boost exports; it can cut interest rates.
Trading on the Chinese stock market was a farce. “Circuit breakers” were introduced at the start of the year to prevent turbulence, used twice to stop investors selling shares, and then abruptly dumped at the end of last week. But the chaos needs to be put into perspective. Only the rich play on the Chinese stock market and their activities have little bearing on corporate investment. Share prices rose by 150% between June 2014 and May 2015: events since have seen the froth blown off the market, but the wider implications for China, let alone the rest of the world, are negligible.
The US-based fund manager Blackrock remains sanguine about the prospects for 2016, seeing events of the past week as akin to the brief period of turmoil last August rather than the start of a bear market. “On balance, the US economy is in decent shape (outside of manufacturing) and economic conditions in Europe are improving as well. The declines in these markets may have more to do with sentiment than substance,” it said.
There is, though, an alternative – and much darker – interpretation of the events of the past week, which begins and ends with China.
Rapid growth in what is now the world’s second-biggest economy helped prevent a second Great Depression in 2008-09, but there was a heavy price to pay. China spent public money lavishly – often on pointless projects – and by making credit cheap and abundant it set off a property boom. There has been misallocation of capital on a colossal scale, resulting in empty office blocks and unproductive factories.
Laura Eaton of Fathom Consulting says Beijing has hit the panic button: “In our view, the ongoing series of stimulus measures employed by the Chinese government merely highlights their discomfort. Quite simply, we believe that their actions belie their words. China is suffering a hard landing.”
Eaton expects the People’s Bank of China to devalue its currency aggressively over the coming months. The impact of that would be to flood the global economy with cut-price Chinese goods, putting added pressure on competing developing nations and turning ultra-low inflation to outright deflation in the west.
All this would happen at a time when other central banks and finance ministries are low on ammunition. In previous economic cycles, countries have gone into recessions with healthy public finances and relatively high levels of interest rates. That has allowed public spending to rise, taxes to be cut and the cost of borrowing to be lowered. Almost seven years into the recovery from the downturn of 2008-09, interest rates in the developed world are barely above zero and the repair job on public finances remains unfinished.
Christine Lagarde, the managing director of the International Monetary Fund, said last week the global economy would remain fragile in 2016. She said there was likely to be an “increased divergence” in monetary policy in developed countries. The fund thinks the Bank of Japan and the European Central Bank will be providing extra stimulus at a time when the US Federal Reserve and the Bank of England are pushing up interest rates. In the past, this has tended to be a recipe for trouble in the markets.
Lagarde also predicted that China’s attempt to rebalance its economy towards consumer spending rather than exports would prove a bumpy process rather than a trouble-free one: the transition was leading to lower demand for commodities, with knock-on effects for those countries producing oil and industrial metals.
Pressures on commodity producers are already evident. Russia and Brazil are in recession; Saudi Arabia has announced an austerity budget and is planning to sell a stake in its state-owned oil company Aramco. If the Saudis are feeling the pinch from an oil price that has fallen from $115 a barrel in August 2014 to $33 a barrel on Friday, other countries in the emerging world are probably getting close to breaking point.
The last time the developing world was in crisis, Alan Greenspan, the then chairman of the US Federal Reserve, rode to the rescue with cuts in interest rates. The dotcom bubble resulted, and when that went pop Greenspan responded by again slashing interest rates. That led to the US sub-prime housing bubble. When that went pop, China came to the rescue while the west sorted out its wrecked banking system.
So what happens if the first week of 2016 is more than a temporary wobble? More quantitative easing? Negative interest rates? Helicopter drops of money? Nobody really knows. As Sir Alex Ferguson once said: this is squeaky bum time.