IT has been an unsettled few days for global markets. Traders in the financial centers of the United States, Europe and Japan have watched as stock prices first plunged, then partially recovered, though were still significantly down from the week before — in fact, the US markets ended down after a torrid final hour of trading. Their counterparts in China, meanwhile, have not been gladdened by any similar recovery; the Shanghai and Shenzen stock markets, which arguably sparked the rout, have continued on their downward trajectories.
There are a few things to keep in mind when considering these events. The first is that valuations on Western stock markets have been high for some time, and not because of particularly strong performances on the companies’ part. Instead, it is the result of a multiyear period of central banks pumping money into global markets through loose monetary policies, of which quantitative easing is the most eye-catching.
This “creation” of money leads to an excess of capital, so assets such as equities and real estate have floated up with the tide, whether or not they have deserved it. Such a campaign of monetary easing has never been seen on this scale before, and many speculate that the subsequent unwinding will be painful as the world’s central banks return to normality by raising interest rates and reducing the money supply once more. Thus, a stock market drop could in some ways be seen as a positive return to a functioning economy, even if the shareholders probably will not see it that way.
In addition, things that should change market valuations are happening, but most of them are not new. Chinese growth has steadily declined for several years, and July’s weaker-than-expected export numbers do not indicate a new trend. The resulting decrease in demand growth has created a squeeze in commodities, which tend to move in long cycles, so it is also part of a longer trend. Commodity-exporting countries (often in the emerging markets) that have been struck by plummeting prices are also dealing with departing capital as money moves to the United States in expectation of a rate increase, compounding their problems and burning any investors still holding assets there.
All of this is not to make light of the problems confronting China’s government. A clash between the Communist Party’s ambitions and its preferred methods for running the country has been coming for a long time. China’s export-led growth model was disrupted in 2008, when all of its customers went bust, and since then it has been shifting toward increased domestic consumption. The problem is that to develop into a modern, Western-style economy with complex capital markets, China will need Western investors wary of investing in a market that is nakedly controlled by its government to get involved. So China’s leaders face bubbles in the stock and housing markets, a slowing economy and high debt levels. And worst of all, every direct action they might take to solve these problems will move them further away from the market model they hope will put China on a path to a stable and growing future.
The world economy is going through a period of change. Emerging markets are finally dealing with the hangover that always follows sustained growth, and the rest of the world is now looking hopefully to the United States to create enough demand to dig them out of trouble once more. The transition is likely to be painful not just for the emerging markets but also for any Westerners still exposed; Spain and the United Kingdom both have more banking exposure than they would like, as does Greece, whose banks may need an even bigger injection of capital from the European Union than has already been agreed upon in the bailout package. Such a period of transition has the potential to create a larger crisis, particularly with asset prices already at inflated values.