Politicians in China don’t have a magic wand – but it’s OK

published 2 September 2015

150902-china-xi-jinping — Chian's premier, Xi Jinping: made a mess of dealing withthestockmarket crash

Up the market rollercoaster goes and down it plunges.

Oil tanked again yesterday. So did stocks. The market isn't ready to shrug off all this China stuff yet.

Yesterday, the excuse was that China's manufacturing sector had started shrinking again, for the first time since February.

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What's slightly baffling is that none of this is news. China's economy has been clearly slowing for a while.

So what's changed to rattle markets so badly?

The world's second-biggest economy has crashed before and no one cared

There's just one problem China has been slowing down for ages. We started warning about a China slowdown a good few years ago. Commodity prices and mining share prices peaked ages ago, too. Oil was one of the last to succumb.

So it's hardly been a state secret. Or at least, China might have liked to have kept it a state secret, but anyone with an ounce of scepticism has known that China's economy wasn't ticking along at the remarkably steady 7% rate presented by its leaders.

In fact, if you look at the figures, most things China-related had suffered what in any other market would be described as a crash' or at least a slump', well before anyone started worrying about it. Luxury goods have struggled for a while. Miners haven't been having much fun either.

"But China is the world's second-largest economy", argue the pundits. Surely it matters? The answer to that is pretty simple: Japan.

Japan was the world's second-largest economy too, for years. It had a crash of such epic proportions that it has become the bogeyman that keeps central bankers awake at night. And ever since then, it has been (and still is) locked in battle with a generally lacklustre growth picture.

Meanwhile, the rest of the developed world, and much of the emerging one, enjoyed a fantastic bull market.

Anyway, we all know that economic growth and stockmarket growth are not at all correlated.

So, seriously this time what's bugging the market?

Confidence, confidence, confidence

The Chinese have demonstrated that they have no idea how to deal with this. It turns out that command capitalism' isn't the miraculous political and economic solution that the more democracy-averse among us had believed.

It turns out that the absence of universal suffrage is no guarantee that you'll get a superior breed of power-crazed egomaniac running your country. The nice thing about democracy is that you get to switch egomaniacs when you get bored with the current one.

Putting it bluntly, the Chinese have made a complete mess of dealing with their stockmarket crash. So now everyone is starting to worry about their ability to manage a smooth' landing for the wider economy.

It's all about confidence, in other words. Investors are worried that China might do something stupid. And that this will have a knock-on impact on the rest of the world.

The central bankers have their deflation handbook out

I have to admit, I have been uncharacteristically sanguine about this particular market slide. I might be wrong. But I'll explain why.

In a nutshell, the obvious forces coming out of any China crash or mistake, are deflationary ones. Much of the world's asset markets crucially, the bond market are pricing in a deflationary future. The developed world's central bankers led by the Federal Reserve are sensitive to any sniff of deflation.

In short, if things get particularly hairy, there's nothing to stop more money-printing. So far, that has proved successful at boosting asset prices. And if it doesn't, they'll just do it until it does.

The big risk then and this is one risk that I am concerned about is that central banks do too much. But that's not what we're facing just yet.

There is one other thing that does worry me more than the rest of the stuff here: that's the threat of defaults in the high-yield bond market. With oil prices at these levels, it's only a matter of time before someone blows up.

But even then, that's still more likely to be a sector-specific problem than a systemic one. People who played in junk bonds and poorly-understood exchange-traded funds will get burned.

Ultimately, this is a squall rather than a hurricane. People are panicking right now, but I don't see it taking much for the buy the dip' mentality to make a comeback. Stick to your investment plan and if you don't have one, may I recommend this one?

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.