When people, institutions or countries behave in a bizarre way, my late father used to say, ‘the world’s gone mad!’ It was a neat way to sum up a situation that didn’t make sense.
I find myself looking at several economic hotspots around the world right now, and saying exactly that.
Late last week the International Monetary Fund (IMF) updated its world economic growth forecast. It lowered its forecast from 3.5 per cent to 3.3 per cent. That’s significant because with extremely accommodating monetary policy around the world, you would expect the fund to increase its forecast if anything. So clearly something’s amiss.
China outdid Greece this week
Last week Greece voted to reject a rescue package from its European neighbours. This week they’ll likely come to some sort of agreement that won’t involve the country leaving the euro zone. It’s been big news. The country officially defaulted.
Despite all that, it was China that grabbed many of the headlines.
China’s a predominantly a communist country but right now it’s dealing with a classically capitalist problem: the management of fear and greed.
Over the past year the share market has risen around 100 per cent. Within this last month it has crashed around 30 per cent.
The share market was a bubble that has now burst.
To stem the rush of liquidity – like any good communist country (tongue in cheek) – it tried to control the market. It even had some success last Friday.
After suspending around 70 per cent of the market from trading, limiting sell side transactions, and massaging margin lending facilities, the market stopped falling. It even managed a small rally. Most analysts, however, accept that trying to prevent a stock market crash is like trying to defy gravity – it just won’t work.
China’s stock market bubble and crash is not, however, a surprise. Indeed we’ve seen it before. In fact its rise and crash during the financial crisis was worse. The problem this time around is that it comes at a fragile time for the economy.
Chinese authorities are trying to shift the country’s economic base from being export-driven, to a more consumer, western-style economy.
Many of the ‘victims’ of this current crash have been retail investors. That helps to explain why the government is working so hard to stem the outflow of cash, but it also highlights how disastrous this market crash has the potential to be if it significantly lowers the wealth of the country’s middle class.
Naturally Australian policy makers are concerned that if China’s economy is negatively affected by this stock market rout.
It could hurt demand for Australia’s exports with the world’s second largest economy. In fact over-supply and a general sense of unease on global markets has already caused ructions in the price of iron ore. One night last week the commodity fell 10 per cent in one session.
China is at a critical point in its economic development right now. I’ll be watching developments very closely this week.
Greece not going away
Greece has been all over the news these past few weeks so I don’t need to give you a compelling narrative of what’s happening.
By the time you read this column I’m sure there will have been more negotiations and yet another deadline set, or arrangement made.
The relationship between Greece and its creditors reminds me of a child who has to work (do chores) for his pocket money.
The child is essentially broke and is completely reliant on his parents for money. At times he will misbehave and there will be threats to take his pocket money away. Indeed he may even protest and refuse to work – the money is then withheld from him.
Ultimately though his parents don’t want him to leave home, nor does he believe he has any real alternative but to stay at home, so he will go on and do the occasional chore.
The child ultimately accepts the authority of his parents in a kind of begrudging way. At the core of the problem of course is a big disparity between the economic strength of the child and the parents. It’s the same scenario with Greece and its European neighbours.
Greece could leave the Eurozone but at this point it’s not something that’s desired by the majority of its creditors or the majority of its people.
What economists, markets and policy makers are most concerned about at the moment is the country literally running out of money.
Banks remain closed and, eventually, the ATMs will run out of money. This week that may change as it looks like a deal may be struck.
There will, however, be more austerity to come, the country will continue to limp along without any clear plan to recover economically, and the capital market risks associated with an uneven Eurozone will remain.
Greece is likely to remain the problem child of the Eurozone for years to come.
The competitiveness of France and Germany will continue to be hostage to Greece’s ongoing economic malaise. The economics of the Greek economy though are so bad the bigger nations simply prefer to keep it afloat rather than face the alternative of the untested “Grexit”.
United States in pain as well
It’s interesting that while China and Greece have been the focus for financial markets recently, everyone seems to have forgotten about the United States.
Last week the IMF warned that its first quarter of growth would be slower than expected. It also warned that it might be better if the US Federal Reserve waited until the first half of next year to raise interest rates, rather than do it later this year. None of this provides me with confidence.
US interest rates are still at zero per cent, and yet the economy is still struggling to produce enough economic growth to achieve rising real wages. It wouldn’t be such a problem if it all wasn’t happening in the world’s biggest economy.
Fear and volatility
The result of all this (slow US growth, Greek debt crisis, and China’s stock market crash) is fear and volatility.
As a result we’ve seen huge swings on the Australian stock exchange, as well as big movements in the prices of oil and Australia’s largest export commodity, iron ore.
Extreme volatility is never a good thing and is usually a sign that something very fundamental is amiss.
In my view, the problem is that the global economy is still recovering from the ripple effects of the great credit crunch of 2008 and 2009. Economies are still struggling to create jobs and real wage increases. Businesses are also reluctant to invest.
And of course there’s that ever growing temptation to seek risk as the return on ‘safer’ capital (like bonds and cash) diminishes.
At the very heart of the issue is a lack of confidence. But that has to come from within. It’s a ‘natural’ process, and it will come back, but when that will be is the biggest unknown of modern economic times.