China has taken another battering this morning. The main market – the Shanghai Composite – has now lost all its gains for 2015. Indeed, China’s state news agency has called it ‘Black Monday’.
And the slump in China is now rippling out beyond emerging markets to the rest of the world. The US market saw its biggest drop in four years on Friday.
Why is this happening? And what’s next?
‘Why isn’t anyone doing anything?!’
Long story short, China is plunging this morning because no one stepped in at the weekend to stop it.
As the FT reports, “many were expecting the People’s Bank of China to cut interest rates or inject liquidity over the weekend, however, no such steps were taken”.
Really, this is what China should have done in the first place. The problem is that China’s authorities set a precedent by panicking badly when the stockmarket first started crashing. Now that they’re sensibly leaving the market to its own devices – it is a market after all – investors are horrified.
With any luck, China’s busybodies have woken up to the fact that a stockmarket correction isn’t the end of the world. But I wouldn’t bet the house on it. I imagine there are some frenzied conversations about intervention going on right now.
And they won’t just be going on in China. After last week, the Dow Jones index in the US is now in correction territory (ie, it’s down by more than 10% from its most recent high).
The big fear right now is that everything is slowing down. Commodities are tanking – oil is below $40 a barrel in the US, less than $10 off the lowest point of the post-financial crisis crash.
Meanwhile, China has devalued its currency. The fear is that we’ll end up in a race to the bottom, with countries making their own goods ever cheaper and hurting each other’s profit margins, and no one will get anywhere.
It’s all very scary.
This is a problem that central banks know how to deal with
There’s just one problem. It wouldn’t take much for central banks to put this all into reverse again.
The Federal Reserve was meant to be raising interest rates next month. Is that likely to happen now? If history is anything to go by, then the answer is ‘almost certainly not’. In fact, I wouldn’t be surprised if a rate rise this year is parked.
Check out the FT this morning. You’ve got Larry Summers, former US Treasury Secretary, writing under the headline “The Fed looks set to make a dangerous mistake”.
He hums and haws and says that there might have been a point earlier in the year at which maybe the Fed could have possibly considered the idea of maybe thinking about contemplating a possible rate rise.
But definitely not now. I mean, have you seen what’s happening out there? The stockmarket has gone down! Not just in foreign countries, but in the US too!
“At this moment of fragility, raising rates risks tipping some part of the financial system into crisis, with unpredictable and dangerous results.”
In short, says Larry – this time it’s different. The banks are well capitalised. Corporations are “flush with cash”. Households have “substantially repaired” their balance sheets.
Instead, we’re now facing “secular stagnation”. A “new normal”. And that means that from now on, we’re going to need “very low interest rates” if we are to get satisfactory growth in the future. In short, the Fed should stop talking about raising rates at all.
The great white whale hasn’t been spotted yet
This is why I don’t think this particular crisis is the one we need to worry about.
Deflation gives central bankers an excuse to do what they do best – pump money into markets. It’s easy. And the more we get used to the idea of money printing, the easier it gets for them to try ever more radical policies.
All that liquidity has to go somewhere. As we’ve seen elsewhere, it usually goes into asset prices.
So, my gut feeling is still that the next crisis – by which I mean ‘the big one’, the 2008-style great white whale of a market-leveller that’ll shake the world’s faith in the financial system to the core again – will be an inflationary one.
That’s the kind of thing that would be harder for central banks to cope with, because it involves doing what they hate doing most – tightening monetary policy. And this inflationary crisis will almost certainly have its roots in everything we’re doing right now to try to stave off a deflationary collapse.
So, here’s my tuppence worth. I think we’re closer to the bottom of the commodity bear market than the top, but I also suspect there’s no rush to buy in. As for equities, enjoy the opportunity to drip feed more money into Japan and Europe at lower prices than you got for your money at this time last month.
I also think you should at least be building a ‘China shopping list’. (Rupert Foster gave us his latest take on events in China in the last issue of MoneyWeek magazine – if you’re not already a subscriber, get your first four issues free).
Oh, and hang on to your gold. Weirdly enough, all those stories about how useless gold is in a crisis that were floating about a couple of months ago seem to have vanished now that it’s going up again.
Don’t worry – I’m sure the naysayers will be back the next time it has a dip. Meantime, you can just be glad that you’ve got a bit of insurance in your portfolio.