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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