During the last two weeks the world’s largest stock markets had a wild time not seen since Lehman Brothers went bust on 15 September 2008. The New York stock exchange in Wall Street lost more than 8% of its capitalization in a few days and then recovered some of the losses to close last Friday 28 August 4% down from 19 August. On “Black Monday”, 24 August the Shanghai Composite index, China’s benchmark stock index lost 8.5% of its value in a few hours. Those daily losses came in excess of the unbelievable cost the Chinese share holders paid during the weeks after the Friday 12 June fall down. By now the Chinese stocks have shed around 35% off their early June value. The rest of the major world capital markets in Europe and Asia have lost smaller chunks of their capitalization. If this is not a new bubble bursting before our eyes then we have lost the meaning of percentages.
According to most analysts the reasons behind the present precariousness in international financial markets, after four to five years of steady gains, are related mainly to two factors. Firstly it’s the fatigue of the Chinese economy which has been the locomotive of global growth during the past twenty years. The second cause of incertitude stems from the prospect of an increase of dollar interest rates by the US central bank, the Fed. Mainstream economists though stop their ‘insightful’ analysis at this point not bothering to mention why the global financial system would stutter if the Fed raises its interest rates by some decimal points or if the Chinese economy stops growing by outsized rates.
Addicted to money for free
The answer is to be found in the fact that the global financial system is addicted to abundant and free of charge money which all the major central banks have injected into the banking systems. The banks cannot any more tolerate to pay anything for the money they usurp. Needles to say that the international financial system is in the hands of a handful of US and EU banks, while the health of the emerging markets, China included, is tightly related to borrowed money at negative real interest rates. On this account the Fed is the largest benefactor of the banks having injected to the US lenders $4.5 trillion during the last five years at zero nominal interest rates.
However, given that from 2010 to 2014 the US inflation was in the positive part of the graph, the American banks had been ‘paying’ negative real interest rates. Those extra gains have to be added on top of the huge profits made by the US banks which have being lending out at interest rates ranging from 6% to 20% the money they got for free. All the $4.5tn they got from the Fed they have spread to the mainstream and mainly to the gray financial markets. Most of that money has ended up in the stock, bond and derivatives markets having created the new bubbles, which have now started to deflate and might burst at any time.
It’s the same disease
The same is true for the Chinese financial markets. According to the latest available data, the internal debt in China quadrupled in a few years to (Renminbi or Yuan) RMB 28.5tn now from 7tn in 2007. The base to build this paper tower comes (also at negative real interest rates) from the central bank of the country, the People’s Bank of China. By the end of June 2015 it has injected RMB 8.90 trillion to the country’s banks. The banks in their turn have lent and re-lent that money and today the overall internal indebtedness in this huge country is even more gigantic and has reached almost the triple of its GDP.
One can imagine what can go off if a critical mass of Chinese private borrowers, local governments and state enterprises start falling in arrears with their loans. Such a dreadful scenario may be triggered if the real overall growth rate of the Chinese economy falls below 7%. This figure, amongst other things, is considered as the lowest development tempo in order for the country’s borrowers to be able to continue servicing their debts. This benchmark development rate for China is also the lowest tolerable rate if the country’s trading partners want to keep their own economies in the positive side, albeit at much lower growth rates.
Beijing doing more
The Chinese authorities have predicted that by the end of this year the overall growth rate will end up at this level. The problem is that many western investors do not believe it and question the credibility of the Chinese statistics. That’s why the Chinese authorities are doing much more to support growth. During the past weeks the Chinese decision makers in order to counter the sell-off in the country’s stock exchange and strengthen the real economy, have being further inflating the already incredibly high unconventional liquidity advancements from the People’s Bank of China to borrowers.
China learns a lesson
Up to now those new monetary expansionist measures have proved incapable of arresting the sell offs. It seems that China has just discovered an unpleasant surprise for its leadership that its own communist kind of capitalism suffers from the same diseases and ups and downs as the democratic one. More than twenty years of continuous double digit growth had created the false impression that China can beat the rules of gravity and direct its markets the way it wanted; always upwards. The sacrosanct of all markets, the stock exchange, finally set things right by showing that all markets are the same whatever the adjective before it. President Xi Jinping and the new leadership of China come to terms with that.
Coming back to the developed world and more specifically to Eurozone, all along these last wild weeks the euro, despite its internal problems with Greece, has emerged as a rather safer placement. Even though the European stock exchanges have paid a dear price to the new uncertainties, the euro gained some grounds with the dollar. This doesn’t mean that Eurozone is immune to the global financial turbulences. However it indicates a rather stronger resistance to possible new financial swings.
Some paid the early costs
In any case the truth remains that if the global markets continue stuttering badly, no country in the world would avoid paying a dear price to the new financial Armageddon. Some medium sized key countries like Brazil, Turkey and South Africa have already felt the shock and have entered a path of economic and political shakiness. Understandably the financial community led by the banks, does not see a major crisis developing and keep asking for more free money, pressing the American Fed to keep postponing the increase of its zero interest rates. The bankers don’t run any danger as the 2007-2008 crisis proved, it will be the real economy to pay the price this time.