The world is now witnessing the limits to government manipulation of the markets and the economy at large. The meltdown in China’s Shanghai Composite Index with a single day loss on Monday of 8.5%, is the second largest in a decade. The Shenzhen lost 7% of it value as well. The fall is a direct result of the 0.3 drop in industrial profits last month. It is a sign that the Chinese economy the second largest in the world, is not heading for a soft landing, but rather a precipitous tumble.
However the real cause in the rapid decline in Chinese markets now near 30% since mid June, may well be the anxiety of investors. There is an astonishment at the level of government involvement, that many fear cannot be sustained over the long haul. The feeling is once the support is withdrawn, the market will collapse. Despite the best efforts of the government, more investors are moving back into real estate which is another troubled sector. The value of home sales surged 30% in the second quarter, after plunging 9% in the first quarter.
Protests in Athens Greece
In Europe, the Greek debt crisis has not been really solved. Negotiators have arrived in Greece this week to begin the difficult process to reach an agreement on a new round of loans. If successful it will allow the infusion 86 billion Euros the equivalent $94.42 billion USD (United States Dollar), for the Greek economy. The participants will be pressed for time. A new deal will need to finished before August 20th. This is the date that Greece must secure the funds necessary, to repay the billions owed to the ECB (European Central Bank).
The Greek Prime Minister Alex Tsipras, is in a major struggle to maintain party unity, that was fractured when the Greek government was forced to pass new austerity measures as demanded by other European creditors. The way forward for Greece is to get the economy to grow again. This seems increasingly unlikely. The GDP (Gross Domestic Product) has already shrunk by 25% since 2009.
There are only three possible solutions for the present Greek dilemma. Devaluation is not possible since Greece has decided to stay in the Euro-zone. There will be no return to the drachma, at least for now. Monetary policy is controlled by the ECB. Therefore the Greek Central Bank is unable to adjust interest rates and the money supply to assist growth within the Greek economy. This only leaves fiscal policy, as the remaining tool to stimulate expansion. As the country is already bankrupt, this is a nonstarter.
The crisis in Greece will not really end because the country is insolvent and will remain so, unless the dynamic changes. The European creditors are reluctant to change the rules because there are a number of other countries in the Euro-zone including Cyprus, Ireland, Italy, Portugal, Spain who are also struggling with debt. If an exception is made for Greece, these countries will also insist on special consideration. Those countries have also gone through some wrenching restructuring, in order to meet the demands of their creditors.
In Latin America, the ending of the commodity boom has brought a halt to rapid growth, for the majority of the countries in the region. The slow down in economic expansion in China and elsewhere, has created a superabundance of many industrial commodities, putting a downward pressure on these manufacturing inputs. Nations like Venezuela which are overly dependent on a single commodity like oil, are watching their economies crumble. It is going to increase the political instability as these nations head for bankruptcy and defaults on their international loans.
A Favela (shanty town) in Rio de Janeiro.
Countries like Argentina and Brazil which were able to witness prosperity despite the corruption and inefficiencies in their economic and political systems, will find the new era quite challenging. Constituencies were content to allow nonsensical policies during times of economic plenty. Now that this epoch is coming to a close, there will be vocal demands for fundamental change.
The nations that are overly dependent on a single commodity as aforementioned, are in dire straits. Outside the Persian Gulf states which have accumulated substantial reserves to see them through difficult times, other countries are in far different circumstances. As the global price of oil continues to drop, there will be more political and social disorder as these governments run out of money. Internationally priced Brent is now just above $53.00 USD.
In the United States WTI (West Texas Intermediate) oil is already priced at $48.79 USD. The plunge in fossil fuel prices is creating big disruptions in the energy sector and leading to job losses in the tens of thousands. World wide the layoffs exceed 150,000 already. Although lower energy prices may well benefit other parts of the economy, the jobs being lost were for the most part higher paying than the ones that will replace them.
Countries around the world are revising previous projections of economic expansion downward. This in turn forced the IMF (International Monetary Fund) to lower expected global growth from 3.5% to 3.3%. The World Bank (WB) has an even more dismal forecast, cutting the anticipated rate down to 2.8% for 2015. The WB based this calculation on the sharp economic contractions in both Brazil and Russia along with the weaker growth in Indonesia and Turkey. It is being complimented by slower growth in most emerging markets.
Japan as the world’s third ranking industrial power has not seen sustainable growth in years. Massive rounds of quantitative easing (QE) and loose fiscal policy, have created a debt level that is now approaching 240% of GDP. Despite the massive spending, the economy limps along with deflation and low productivity.
A new government in office since 2012, has promised a return to prosperity through what has become known as Abenomics. The economic recovery plan consisted of three main features. It was to boost government spending, unleash monetary stimulus and lastly structural reform of the economy. The first two have been embraced enthusiastically, the last one has become far more problematic.
In the United States the slowest economic recovery on record staggers forward, more a result of monetary policy than actual growth. As the largest economy globally, interest rates have not been increased since 2006 and deficit spending has exploded. After the financial meltdown of 2008, the country embarked on massive amounts of QE, that were finally tapered off in late 2014. The result of all this spending has been a doubling in valuation of the United States Stock Market, but a GDP to debt ratio of 105% and a national debt in excess of $18 trillion USD.
Interest rates continue at 0.25%, essentially near zero. Every meeting of the Federal Reserve Bank (Fed), the American equivalent of a central bank, brings a threat of rising interest rates that keeps being postponed until a later date. The markets wait in anticipation and then breathe a sigh of relief that once again, the present policy is to be maintained. What follows is another small rally with stocks with investors seemingly content, that money will remain cheap for the immediate future.
Protesters in Dublin, Republic of Ireland.
The artificial low rates in interest have made the stock market in the United States and elsewhere, the only real place to invest money with the expectation of a reasonable return. The race to the bottom in interest rates, have gone to the point where there are below zero rates in countries like Denmark and Sweden. It is a totally absurd monetary position, that cannot be maintained in the long run. The financial system in these countries actually punishes savers. This is not a recipe for generating real investment and growth.
As the debasement in national currencies continues apace along with the massive run up in debt in the advanced countries of the world, the arrival of zero returns on most investments outside stocks has already arrived. More traditional types of investment in commodities, precious metals, real estate and government bonds have each in turn, proved to be poor vehicles in generating profits. So an ever greater share of national wealth is poured into stocks, forcing valuations ever higher. It has gone way beyond what is prudent and reasonable, given the poor rates of economic growth.
Barely a week goes by, that a country is not lowering interest rates even further. Australia was the most recent example. Yet, each round of cuts forces a similar action elsewhere. The finance minsters in most countries seem to have run out of ideas, how to further stimulate growth. When prosperity fails to arrive, all that is offered is another round of fiscal spending, even lower interest rates and more policies of quantitative easing.
At present only a few countries remain skeptical of these actions. They continue to issue dire warnings of what these inexpedient financial policies will eventually bring. Nations like Germany, Norway, Singapore and Switzerland are doing what they can, in keeping national budgets in balance and keep their foreign account balances in positive territory. Exports have so far kept these countries prosperous,but it is becoming increasingly challenging, as world economic growth continues to slacken.
What will follow is inevitable. A major correction in the markets will soon arrive, either in the second half of 2015 or in 2016. The resulting recession will be harsh with governments unable to respond in a meaningful way, because of the magnitude of the downturn. The long awaited restructuring of many national economies, will finally have a greater urgency.
As the international defaults and moratoriums on debt payments mount, massive disruptions in the world economy will result. The untold misery of the citizens who have allowed their respective governments to spend their way into bankruptcy, will bring civil unrest and political upheaval around the globe. It will take years to recover from the foolish and dishonest economic policies that have been enacted over the past few years.