The Great Fall of China, Black Monday, call it what you will. The Shanghai main board collapsed last week with a relentless ferocity that brought back the worst days of the global financial crisis and dragged down global equities with it. This, we were told in certain quarters, was the beginning of the financial crisis part two that will make the prequel seem tame by comparison.
Larry Summers posted a rent-a-quote piece of portent on Twitter: “As in August 1997, 1998, 2007 and 2008 we could be in the early stage of a very serious situation.” Oh dear.
There were more bizarre snippets of commentary straight from Dante’s fifth circle of Hell. Damian McBride, ex-adviser to former British prime minister Gordon Brown was advocating the accumulation of tinned goods, bottled water and other essentials to enable living a month indoors if necessary.
We were not to assume that ATMs would be working and to have a rallying point at which to meet loved ones should transport and communication services be cut off. What nonsense.
The Dow managed to put on its third-best points gain last Wednesday, rallying more than 600 points and European and Asian bourses also recovered, although the received wisdom seems to be that these are the bounces of a dead cat. My opinion is that the contagion from China’s equity market fallout was overdone and that buyers will emerge from the ashes of last week’s price action.
BUT WHAT WAS it all really about? There are a few explanations. One is that the Chinese authorities should have acted at the weekend rather than during the week in lowering interest rates and cutting the reserve requirement as they did last Tuesday. A few days too late and it looked reactive rather than proactive.
Another cause is the ambiguity surrounding whether or not the US Fed will raise rates in September or remain on hold. We saw the damage done to markets a few years back when the Fed first mentioned an end to QE. People don’t take Fed uncertainty well at any time and this was the mother of all uncertainties.
But if China had got busy last weekend and Shanghai had seen more muted price action as a result, would that have increased the odds for a Fed tightening? The mood in Asia’s debt markets last week was that they should get the rate rise out of the way and then everyone could move on with their lives. As it is now, Janet Yellen and co are sitting in the box labelled “damned if they do and damned if they don’t” and it’s all China’s fault.
The truth is that a rate rise in the US is probably necessary even though inflation remains muted, underpinned by the collapse in global commodity prices. Jan Dehn of hedge fund Ashmore reckons inflation will resurface in the US next year as household deleveraging draws to a close, unemployment falls further and a the drag of negative equity on households is lifted.
I have always favoured anecdotal evidence over data and if my mate who has just spent a month back home in Chicago is anything to go by, the States is on a roll. Everyone’s got jobs, bars and restaurants are bustling and it’s feel-good wherever you go. Time for a rate rise then.
It’s worth remembering that the Fed does not always regard inauspicious exogenous factors as a reason to stand pat on rates. The US central bank raised rates five times during the worst of the Asian financial crisis almost two decades ago. I reckon they will again, but we may have to wait a few months for it.
AS FOR THE Chinese authorities, as I wrote here a few weeks ago, they will throw just about every piece of ammunition at their disposal to be seen to be on top of events. And I think those who would take aim from the short side should start to internalise a new mantra: just as you “don’t fight the Fed” so in the present circumstances you “don’t fight Beijing”. Sure, they may be kicking the can up the hill, but they have the firepower to kick it a very long way.
Perhaps the real reason for the almost cartoon-like collapse of China’s equity markets last week is that we are witnessing the fallout from China’s economic transition.
These are ructions that float over the real agenda: the transformation of the renminbi to reserve currency status, the opening up of China’s capital account, the shift from an export-led to a consumption-led economy, the liberalisation of the rates markets and a gargantuan dollop of disintermediation away from bank lending to bond financing.
China is building a municipal bond market from scratch that is likely to end up as the biggest in the world. Regulators are also feeding the buy-side, again building a mutual fund industry from scratch and opening up domestic markets to offshore investors.
The Chinese equity market is a sideshow, not the main arena. Sure, of course, playing host to collapsing equity markets is not a good look for the notoriously proud and thin-skinned Chinese authorities. They will act to save face where they have to. But the real story is elsewhere, and it’s ticking over quite nicely.
