quarta-feira, 13 de janeiro de 2016

Is this really 2008 all over again?

Is this really 2008 all over again?
Jan 7th 2016, 10:10 BY BUTTONWOOD

GEORGE Soros's record is sufficiently impressive, particularly on macro-economic calls, that it is worth taking notice when he sounds the alarm. His latest suggestion is that the current environment reminds him of 2008, the prelude to one of the worst bear markets in history. The reputation of George Osborne, Britain's finance minister, is nothing like as elevated but he is also set to warn today that the current year may be the toughest for the global economy since the financial crisis.

Stockmarkets certainly seem to be acting as if Mr Soros might be right. China has suspended its share trading for the second day this week (as our correspondent argues, this looks like a counter-productive tactic). The sell-off has rippled through Asia and Europe, with London's FTSE 100 back below 6000 (it closed the last century at 6930; so much for the argument that stocks always pay off over the long term). As yesterday's post pointed out, the sell-off is down to a combination of worries about a slowing global economy and geopolitics.

So is it 2008? Mainstream forecasters aren't predicting recession (but they never do). The World Bank has cut its forecast for global growth in 2016 from 3.3% to 2.9% (although that would be better than 2015's outturn). Perhaps one should look at the trend in forecasts, rather than the outright level; back in January 2008, Federal Reserve governors were looking for 1.3-2% growth that year. That was way too optimistic, but the direction of travel was right; the previous range of forecasts (in October 2007) had been 1.7% to 2.5%. Falling commodity prices and (in the first few days of the trading year) falling bond yields are an indication that investors are worried about growth.

There are certainly signs of weakness in the manufacturing sector. The US manufacturing ISM indicator is at 48.2, below the crucial 50 level; the long-term picture shows that it has been weaker than this level, without indicating recession, but a fall below 45 would be a pretty reliable signal of a downturn. China's manufacturing PMI is at the same level. Global trade is also sluggish; something that economists struggle to understand.

On the other hand, the services sector (by far the largest part of developed economies) is pretty robust; its December ISM was 55.3 in the US. The ADP figures showed a strong rise in US employment in December (the non-farm payrolls are out tomorrow). And not all the news in manufacturing is bad. German new orders were up 1.5% in November, the second consecutive strong monthly rise, prompting Andreas Rees of Unicredit to argue that

the widespread pessimism, especially on stock markets, is largely exaggerated. Instead of further steep plunges in foreign demand for German exporters, it looks as if there is a turnaround.
A judicious view might be that global growth is still sluggish, but it will probably need some trigger to plunge it into outright recession. Geopolitics is one possibility; Iran has just accused Saudi Arabia of bombing its embassy in Yemen and if the Sunni-Shia proxy war turned into a real war, that would surely have a powerful impact.

But the 2008 parallel can only be sustained if we are talking about a debt bubble bursting, and Mr Soros specifically focused on China.

To the extent there was euphoria and rampant speculation (as there was in 2006-07), we are really talking about China rather than Europe or the US.

As the chart shows, there has been a sharp rise in China's debt-to-GDP ratio, with a 50 percentage point increase in the last four years. Just as with the sub-prime loan boom in the US, a rapid increase in debt suggests that loans are being made without sufficient attention being made to credit quality and that resources are being misallocated. The general consensus, however, is that China can handle a debt crisis; state control of the economy is much greater and the government has trillions of dollars of reserves with which to rescue the banks if it needs to. Nor are Chinese banks as tied into the western financial system as Lehman Brothers and Bear Stearns were; the contagion will be limited.

Of course, this state control means that non-performing loans are not recognised as quickly as they are in the west and that, as a result, struggling companies do not go out of business. These zombies hang around and make it much more difficult for competitors (including western companies) to be profitable. So the contagion effect will not be via the financial system but via corporate profits.

John-Paul Smith of Ecstrat, a noted bear on China, argues that

Whilst the majority of industrial enterprises have reacted to the slowdown in demand in a rational manner by reducing capex as proportion of sales, the aggregate impact of their actions is exacerbating the pronounced deflationary tendencies in the broader economy, so that capacity utilisation at the majority of enterprises is still falling, while debt levels continue to move higher.
The fear is that the Chinese authorities, desperate to avoid the social unrest that would result from unemployment if businesses fail, will choose instead to devalue their currency. The yuan has weakened at a measured pace already in 2016 and investors have reacted with concern, but the shock would come from a much bigger fall. China's real effective exchange rate (see the chart from the St Louis Fed) is now 130, compared with an index level of 100 in 2010.

Capital flight from China is already occurring and the stockmarket falls are likely to encourage more outflows. As Mr Smith points out

aggressive intervention to shore up the currency by selling dollars from the FX reserves, will tighten domestic liquidity and therefore risk exacerbating the very conditions, which have brought about capital flight in the first place, thereby triggering a vicious circle.
If China devalues, then other Asian nations will come under pressure to follow suit, for fear of losing competitive position. That will trigger worries about those Asian companies that have borrowed in dollars. There could be banking issues in Asia (read more about emerging market debt problems here).

This is a potentially worrying scenario. Whether 2008 is the right parallel is another matter. If the bearish case does come true, then it sounds more like 1998 when a round of Asian devaluations was triggered by the realisation that growth had been fuelled by speculation. Western economies did manage to overcome that crisis. The real worry is that emerging countries are a lot more important for the global economy than they were back then.

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