On day one the stock market fell by 13%. On day two it fell by a further 12%.
On day three hopes were high the storm had blown over after equity prices recouped the previous session’s losses. Let this be a cautionary tale. These figures relate not to the Shanghai Composite index in August 2015 but the Dow Jones Industrial Average in October 1929.
Even in the most savage bear markets prices never fall in a straight line. Instead, within a downward trend big daily falls are punctuated by sizeable daily rallies. Events of the past few days conform to this pattern, at least in Europe. Shares in London, Frankfurt and Paris fell heavily on Friday and Monday, then recovered on Tuesday.
For a good while, there was every indication that New York would follow the same pattern. The Dow Jones Industrial Average was up more than 400 points at one stage only to suffer a bout of jitters in the last hour of trading to close more than 200 points lower.
This is a bad omen. Markets were not over-impressed when China hit the panic button by both cutting interest rates and allowing banks to lend more money. Wall Street’s late loss of nerve suggests there is a lot more turbulence to come, with attention firmly focused on China, where the authorities have given up intervening to prop up the stock market in favour of intervening to prop up the economy.
The statement issued by the People’s Bank of China pointed out that economic growth was facing “downward pressure”, and there will be further easing over the months to come as the weaknesses of China’s economic model become apparent.
It is not just that the growth rate of the world’s second biggest economy is faltering, it is that the quality of that growth is deteriorating.
Mike Riddell of M&G notes that the share of gross domestic product accounted for by investment rose from just over 40% in 2007, to 48% between 2008 and 2013, to 54% last year. A higher investment rate is normally associated with higher growth; in China’s case it has been associated with lower growth.
Riddell’s conclusion is that much of the investment has been wasteful and that China is “trying to hit unsustainably high GDP growth rates by generating bigger and bigger credit and investment bubbles”.
The stock market bubble has now well and truly popped and the rebalancing of the economy away from over-investment has not yet begun. China’s leaders cannot stave off a hard landing for ever. Indeed, the hard landing may already have arrived. This financial crisis is not over. The question is what impact it will have on the global economy. Optimists point to three reasons to be cheerful.
The first is that the risks of financial contagion from China’s stock market crash to the rest of the world are limited, because most losers will be Chinese companies and Chinese individuals. That’s unlike the crash of 2007, when the whole world had bought into the US sub-prime boom. The second is that almost every recession since the second world war has been preceded by a sharp rise in oil prices, yet in the past year the cost of crude has more than halved.
Third, the last really serious emerging market crisis in 1997 had no discernible impact on developed nations.
Such optimism may be a bit premature. For a start, emerging markets are now a bigger part of the global economy. China represents 17% of world GDP once differences in the cost of living between rich and poor countries are evened out, and has accounted for almost 30% of global growth since 2010. The low oil price reflects the fact that some big emerging market economies are in recession and are exporting that recession to the west.
Finally, developed countries responded to the 1997 crash by slashing interest rates. That option is unavailable this time.
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