Is needless panic sending the world to the brink of recession?
Andrew Sheng says financial markets have been propped up by massive unconventional monetary policy and negative interest rates, so we should not be surprised if these bubbles deflate
As Asian corporate and financial leaders migrate to Davos for the World Economic Forum, the global financial markets seem to be saying that 2016 is on the brink, with the Dow Jones Index losing up to 11 per cent since January 4. The worry is all about crashing oil prices, a China slowdown, Islamic State bomb attacks, European migration and slowing global growth. At the same time, confidence in political leadership is not helped by Donald Trump’s remarks in the run-up to the US presidential election.
Forum founder Klaus Schwab kicked off with a thoughtful article on the fourth industrial revolution, driven by scientific and technological breakthroughs. But it was an Oxfam report that grabbed the headlines – “62 richest persons own more than poorest half of the world’s population”. Oxfam suggested that if US$7.6 trillion of individuals’ offshore wealth was taxed, governments around the world would get US$190 billion annually to address inequality. But, since quite a few in Davos manage money for the rich, few policies are likely to come out of there to address global inequality.
Is the world teetering on the brink of a bear market or recession? There is no question that risks are higher, because too many factors are changing at the same time. Global financial markets have been propped up by massive unconventional monetary policy and negative interest rates, with unprecedented bull markets in equity, bonds, real estate and commodity prices. We should therefore not be surprised if these bubbles deflate when the two key drivers of prosperity in the last five years are signalling “normality” – the Fed on interest rates and China on growth.
Markets are driven by greed and fear. We had our greed binge, so fear is now being fed by news that says everything in China must be bad and that oil will go to US$20. In the 1990s, a former Brazilian central bank governor reminded global bankers and fund managers that if they shorted the Brazilian currency too much, what they made would be cancelled out by their losses on their Brazilian loan book. The tail of financial markets is driving the real economy.
The market fear of lower oil prices is actually overblown: low oil prices are very good for the average consumer and industrial energy users. China, India and Japan all benefit. However, consumers may not necessarily be willing to spend at the moment, because many are also worried about their jobs.
The other puzzle is that, in both the US and China, job numbers are holding up very well. The US services sector, which accounts for 86 per cent of jobs, increased by 2.3 million last year, one reason why the Fed finally raised interest rates.
In China, unemployment has been flat, at 5.1 per cent, because the labour force shrank by 4.87 million due to population ageing and a return of migrants to inland provinces. It is the labour shortage that is holding up wages and therefore internal consumption. The fact that the economy has slowed, but unemployment has not shot up, is a good sign that productivity adjustments are being made.
What spooked fund managers about China is the direction of the yuan. There are two possible explanations for the People’s Bank of China’s renminbi operations since August. One is that, in line with currency internationalisation and IMF expectations of a freely usable yuan, the central bank is moving towards using a basket of currencies (as yet undisclosed) as a benchmark for the renminbi. The second is that the policy is geared at some depreciation against the dollar, but stable against the benchmark basket. However, in the confusion, the market simply did not understand the central bank’s actions.
READ MORE: Beyond the pessimism – Why sustained, healthy development will be the new normal for China’s economy
My worry is less about the real economy and more about how fund managers are psyching themselves and retail investors into a panic, which risks being self-fulfilling. Real economies do not move as quickly or sharply as financial markets. As one fund manager said, it is time to get out of the water.
One reason why retail investors should get out is because there are too many sharks. The joke is that fund managers don’t eat shark fin soup – not because they care about the environment, but because of professional courtesy. Investors beware.
Andrew Sheng comments on global and Asian affairs