You will have noticed this last week how a sneeze in China can create strong flu symptoms around the rest of the world. Not even the Fed, with its desire to raise interest rates, has the power to move the markets as much. To be fair, the data from China that spun the markets this last week was somewhat unexpected – and the Fed communicates its plans ahead of time. But the real point is that small changes in data from China have a bigger impact on global markets than small changes in data from the US. And this is just the start.
Economists and market pundits have been fixated on when, if, and by how much and fast, the US Federal Research will raise interest rates. The false start in September 2015 was superseded with an as-expected rate raise in December. Now the expectation is that through 2016 the US economy will experience a full 1% raise. This may or may not take place. I am of the opinion that it won’t – and that the US Fed will regret raising rates and will be forced, due to worsening global economy conditions, to lower rates again before the year is out. But even if they continue to raise or cut rates, I don’t think it matters much. It matters a whole lot less than what is going on in China.
China’s economy is in a unique position. It has been the largest single contributor to global growth for several years. This growth has been created by debt induced spending, mostly related to manufacturing and massive growth in state controlled businesses. Growth we know is slowing and continues to show signs of falling further. The country sits at a cross roads as the authorities know that they need to shift the economy from a manufacturing/export-based market to a consumer/consumption-based market, but this cannot be achieved in a year. As we sit here and ponder these shifts, manufacturing and confidence in manufacturing are contracting and this continues to drive down commodity processes which transmits deflation globally. At the same time, debt levels are at all time highs and the profits from state controlled industries are falling and showing signs of remaining negative for some time. See China Faces Era of Hard Trade-Offs in Saturday’s US print edition of the Wall Street Journal.
The reality is that the Chinese economy will either have what is called a hard landing in 2016, or a soft landing. A hard landing is a more disruptive collapse of demand that will create damaging ramifications, I mean more damaging ramifications, for the global economy. A soft landing may result in a gradual softening of demand and a chance for the Chinese leaders to cope with the result and so smooth out what would otherwise be disruption. The fact is that China is not a market economy, it’s currency is not free floating, and despite all the kind words from the IMF, it won’t be so for some time – if at all. China is a managed economy and unless its decision makers are well versed in economic theory and history, their ability to manage all the necessary levers across industry, monetary and fiscal policy, while at the same time balancing social upheaval with political dominance and a rising middle class, it can only result in one outcome: volatility.
We don’t need to bet on whether China will succeed with a soft or hard landing. We can assume one or other will take place but we should assume that increased volatility in the Chinese economy, and thus the global economy, will be the norm for at least 2016, possibly into 2017. With that said, we can also conclude that there is little that the US can do to mitigate such dynamism. China’s movements and policy changes, however communicated (or not communicated), will have more impact on the global stock market, funding/debt levels and currency movements than anything anyone else can do.
If ever there was a need for real coordination, between central banks of US, Europe, Japan, China and UK, it is now. If only the IMF had the mettle it was meant to have it would call just such a meeting – a Bretton Woods 2.0. Fat chance. Hang on chaps, it’s going to be a bumpy ride. And look to the East. From there is where the economic dragons breath will hail.
Update January 12 2016 – Aee “FT Big Read. Markets – Looking for Clues” for a good write-up concerning the strengths, and otherwise, of the Chinese economic leadership.