The Chinese economy grew at its fastest pace in a year during the third quarter. GDP was up 8.9% on the previous year.
So naturally, markets across the rest of the world have taken it badly. Nothing too extravagant – just a vague pall of gloom hanging over the major indices.
Why? Well, Chinese growth came in a tad under the 9% expected. But 8.9% still looks pretty healthy. And that’s the real problem as far as the markets are concerned.
If the economy is looking like it’s on the road to recovery, then the Chinese might think about pulling some of the ‘stimulus’ out of their economy. And in their heart of hearts, everyone knows that stimulus is the only thing keeping this show on the road right now…
Investors are banking on cheap money conditions continuing…
The other night, at the latest MoneyWeek Roundtable discussion (you can read the whole thing in this week’s issue of MoneyWeek magazine, out tomorrow. If you’re not already a subscriber – subscribe to MoneyWeek magazine), one of our regulars, Tim Price of PFP Wealth Management, made a very telling point. He talked about there being a spectre in the room – the spirit of Chuck Prince, the ex-chief executive of banking giant Citigroup.
Prince, for those who don’t know, is the man who, way back in July 2007, just before the credit crunch kicked off, delivered what was probably the single most revealing quote about the nature of the credit bubble.
Demonstrating that he and everyone else on Wall Street and the City knew the good times couldn’t last forever, he said: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
As we all know, the needle skidded off the record pretty sharpish after that, and Prince was among those who were culled as a result. But now that the liquidity is flowing freely again, courtesy of central bank money printing, the game of musical chairs seems to be back on. And that puts a lot of pressure on investment professionals in particular to join in the game.
As Tim put it: “What I sense is that people are half-heartedly buying into markets, specifically stocks, but with some version of the ‘greater fool’ theory at work – the idea that whether it’s stocks or property or whatever, there is going to be enough momentum to drive things forward. That’s just a really lousy backdrop for making rational investment decisions.” (By the way, you can read more from Tim and his tips on how to protect your wealth in today’s uncertain investment climate in his fortnightly Price Report newsletter.)
In other words, investors are banking on cheap money conditions continuing – which is precisely what was driving markets before the last big bust.
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… but they won’t last
Back then, stocks made a habit of falling back on good news too – because the stronger the economy, the more likely interest rates were to rise. Now investors are getting twitchy about the idea that governments around the world might start withdrawing that cheap money.
As Bloomberg put it, after the Chinese data came through: “the dollar headed higher and Asian stocks dropped on concern that the acceleration in China’s growth will spur policy makers to consider withdrawing record fiscal and monetary stimulus in coming quarters.” Already, Qin Xiao, head of China’s fifth-largest bank, China Merchants Bank, has warned that central banks face a tough job ahead. Writing in the Financial Times, he said: “The dilemma is this: if we tighten monetary policy, there is a high possibility of a ‘second dip’ next year: and if we continue the loose policy, another asset bubble might be not far away.”
Of course, asset-price bubbles are exactly what the financial world – and Western central bankers – seem to want. So the idea that you would resist them is a slightly alien notion to British and American investors.
Why Brazil is taxing foreign investors
But it’s not just the Chinese who are worried. Brazil earlier this week imposed capital controls. Foreign purchases of stocks or local currency bonds will be subject to a 2% tax. This isn’t an entirely new step – Brazil imposed a similar temporary tax of 1.5% on bonds last year – so it (hopefully) doesn’t represent a big move back towards heavy intervention in the markets. And the tax isn’t being imposed on foreign direct investment (to build factories and the like) so the country isn’t trying to put off foreigners from buying Brazilian altogether.
Instead, Brazil is attempting to defend itself from all the cheap money flowing in its direction from the West. Emerging markets (for want of a better phrase) have years of bitter experience of hot money flooding in and out of their economies causing havoc. Having conquered its inflation problems in recent years, the last thing Brazil wants is for them to erupt all over again because the US would rather let the dollar slide than deal honestly with its troubled banking sector.
That’s not to say that the 2% tax will do much good – it’s no doubt easy to get around and these sorts of impositions rarely do exactly what you hope they will. And it’s never encouraging to see a government introducing new taxes – they’re very hard to get rid of. But with the US government so heavily entrenched in manipulating its own markets, how is any other government in the world supposed to take a hands-off, laissez-faire approach?
Cheap money conditions in the West may well continue for longer than people expect. But with the rest of the world agitating for tighter money, markets could come unstuck well before Mervyn King or Ben Bernanke decide to raise rates.
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