Will the panic over China continue to spread?

Phew. That was something you don’t see everyday.

For a brief period yesterday, the Dow Jones index was down by more than 1,000 points.

Sure, at the end of the day it’s just a big number. In percentage terms it wasn’t even close to being the biggest fall on record.

But, given that we’re all only human, it’s forgivable to feel a sense of awe and mild panic when that sort of big red number flashes up on a screen.

The question now is – are we set to see a lot more big red numbers? 

Why are markets so rattled?

The Dow Jones yesterday closed more than 500 points lower. Most market participants would probably have seen that was a good result, which shows you just how frenetic the start of the session was.

What’s got investors worried? In a word, China. (At least it makes a change from Greece, I hear you say.) But it’s a bit more complicated than that.

Here’s where we are. We have a situation where most global asset markets are expensive, compared to history at least.

Bond prices are high. Equity prices are high. Property prices are high – pretty much any asset that can be valued based on an income stream, looks highly valued. Same goes for ‘trophy’ assets, whose prices simply reflect the amount of money available to the very wealthy (we’re talking about things like art and cars – things that cost money to keep, rather than earning an income for you).

If you have any sense at all, you probably understand that these elevated prices have at least something to do with the fact that, globally, central banks have printed reams of money and kept interest rates close to 0%. Some central banks have even explicitly stated that asset price inflation is a goal of said policy.

Depending on your political or economic persuasion, you may think this is a good thing. You may think it’s a bad thing. (I’m in the latter camp, in case you hadn’t twigged that by now.) But few dispute that it’s a factor.

So we have a backdrop of arguably expensive markets that have been propped up to some extent by central bank policies. And the biggest central bank in the world – the US Federal Reserve – is now on the verge of raising interest rates.

That’s got to make for a jittery market. It’s not going to take a lot to rattle that market.

So, in steps China. First, they go and have a stockmarket crash. Who cares, right? It’s more than doubled in under a year, you’ve got to expect similar volatility on the way down.

Trouble is, the Chinese have been presenting us with this outward facade of slickly-run ‘command capitalism’. They can tell the economy what to do and when to do it. They’re in control. They can simply click their fingers and turn China from an economy built on carpeting its back garden with high-speed rail tracks into one based on voracious consumerism.

This vision of cool, calm, brusque-but-firmly-in-charge technocrats running everything really appeals to a generation of Western traders brought up under the Fed’s own brand of command capitalism.

So, when China’s authorities destroyed this illusion of calm control by panicking like a bunch of eurozone politicians – decrying hedge funds and short-sellers and effectively trying to ban stocks from falling – well, that unnerved anyone who thought that the Chinese were ‘on top’ of things.

When the Chinese then decided to let the yuan float more freely against the US dollar, that really got people worried.

Remember – allowing the currency to float more freely is a good thing. It’s a reform that China needed to make. Sure, it was nice and convenient to do it at a time when the yuan was being dragged up with the US dollar. But it shows China embracing the market, rather than moving away from it. But in the context, it looked like more panic.

We then get more weak economic data from China at the end of last week. And basically, everyone lost their nerve.

Hence the plunging markets.

China is scary, but this isn’t yet an existential crisis

This isn’t that different to the various panics around Greece. No one is quite sure of what the implications are (how much exposure do we have to China? To crashing commodity prices? Are there any Lehman-type surprises out there?).

And at a time when markets have grown horribly used to a central banker or politician patting them on the head every time something scary happens, no one seems to be taking charge. So, it’s a case of ‘sell first, ask questions later’.

But if you look at it, it’s hard to say that what’s happening right now represents the same sort of existential crisis that brought us the global crisis of 2008.

Falling commodity prices simply isn’t bad news unless you’re a miner. They are short-term deflationary, but in consumer economies at least – which very much includes the UK – it’s a boost to demand, not a drain.

If you have trouble wrapping your head around this, then let me rephrase it. If the government cut petrol taxes to 0%, is that deflationary or inflationary? There you go.

I’m not dismissing the slide – with markets overvalued and investors jittery, we could well see a lot more volatility. It’s likely to be scary out there for a while.

The Chinese market has continued to plunge this morning. The good news – in as much as there is any – is that the authorities seem to have given up. They haven’t bothered to intervene to stop the market from falling.

Meanwhile, the rest of Asia has recovered some of its composure. Europe and the UK are rebounding. And it looks as though the US markets will bounce back today (that’s what the futures markets suggest, though of course that can change).

As I said yesterday, we’re going to see another ‘big one’ in the future. But this here, right now – this isn’t it.

We’ll have more on this in the next issue of MoneyWeek magazine, out on Friday. If you’re not already a subscriber, get your first four issues free here.

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