‘Global markets are irrational’

By Satur C. Ocampo
At Ground Level | The Philippine Star

The 2008-2009 global financial and economic crisis – euphemistically billed as the Great Recession – has hardly been licked. Yet financial reportage and analyses in the past week, and the financial-business elite’s discussions at the World Economic Forum in Davos, Switzerland focused on fears of a looming “new” global recession.

Blame for such a dire prospect has been heaped on three factors: China’s sharply decelerating economy; the plunge in crude and oil prices; and the slump in global financial and commodity markets. Although all these are interlinked, no consensus has yet been reached.

Two International New York Times articles – one about the plunging markets, the other on the US dollar’s rise in value – both conclude: irrationality has a lot to play in the history of economic crises.

Let’s take a cursory look at these factors.

On China’s economic downshift from two decades of double-digit growth rates. At the Davos Forum, which ended last Saturday, hedge-fund billionaire player George Soros said that China is at the root of the looming financial crisis and that a “hard landing is practically unavoidable” for its economy, now the second largest in the world (next to the US).

Now and in 2008, Soros said, the financial market conditions were similar. “But the source of the disequilibrium is different,” he hastened to add. In the 2008-2009 crisis the main cause was the US subprime mortgage crisis. Today, he claimed without elaborating, “the root cause is basically China.”

IMF managing director Christine Lagarde saw a big problem with how China communicates to the world its economic actions that could spur negative or perilous reactions. For example, she cited the Chinese government’s interventions in the stock market to arrest its plunge. Seconding Lagarde’s view, Goldman Sachs president Gary Cohn however pointed out that China’s interventions were “the exact replicas that many countries, including the [US], have done in certain parts of their modern history.” Capping that discussion was the acknowledgment by Fang Xinghai, vice chair of the China Securities Regulatory Commission, who said: “We are learning. We are doing it. [But] we should do a better job.”

China’s official GDP growth rate in 2015 was 6.9 percent, its lowest in 26 years. However, one source said its national debt was growing more than twice that of its GDP. Harvard economist Kenneth Rogoff warned that China’s huge government debt would be a shock to a financial system that “amplified shocks.” And US giant bank Citicorp reportedly sees a 65 percent chance that China will lead the global economy into recession in 2016. (Nobody spoke about how China’s $3.33-trillion foreign exchange reserves are factored in.)

On the drop in crude and oil prices. In the last two years crude and fuel prices have progressively declined to $30 a barrel, from a high of $105 in mid-2014. Although this has been welcomed as a boon to most crude and oil importing economies, it has impacted adversely on the oil producing countries – including the US and Canada.

A recent INYT editorial observed that as a consequence of the price slump, what used to be the “oil-rich nations are not so rich anymore.” Pressure has built up on Saudi Arabia and other oil-producing states to raise money by selling part of the investments they had made from oil wealth. From April to September 2015, these producers pulled out $100 billion from their investments.

That may not be worrisome, considering that these countries owned much of the $7.2 trillion in financial portfolios called sovereignty wealth funds (SWF) held in the US and other financial centers. What’s worrisome, particularly for investors and policy makers, is that the SWF are not subject to heightened regulatory standards. Ergo, “no one can say with precision how much or when the markets could be affected by the investment moves of the oil producing nations.”

As for the US and Canada, they have contributed to the crude-oil glut by rapidly developing the shale oilfields in North Dakota and Texas. Over five years, they have raised $1.3 trillion from loans and bond issuances. With the price slump, the shale industry has imploded, many oil producers have shut down, and at least $200 billion in debts are unsure of being repaid, according to one estimate.

Lower oil prices also jeopardize the Federal Reserve’s plan to raise interest rates this year to spur faster US economic recovery. This prospect impelled a former Fed adviser, Andrew Levin, to say: “I think the Fed has to take seriously the possibility that [the US] could enter into another economic downturn. There’s a feedback between financial markets and the economy. You might think markets are irrational, but even if they are, that spills over into the real economy.”

On the slump in financial and commodity markets. A front-page article in the INYT last week, titled “Making sense of plummeting markets,” begins with this contrast: whereas the IMF sees the world economy growing by 3.4 percent this year the global financial markets warn: “Run for the hills! The sky is falling!”

In the first three weeks of January, the article says, global stock, bond and especially commodity markets have “swung in ways that suggest this is a perilous time… their volatility and direction are consistent with the prospect of a new crisis or global recession.” It cites the drop in oil prices and bond and currency markets pointing to economic trouble in oil-producing nations; and stocks indexes in many emerging countries are even more down.

“What make these falling prices unnerving is that it’s hard to tell a simple story about what is driving them,” the article laments, adding: “More frightening: The markets could be pricing in some darker facts about the outlook for the world that economists don’t fully understand. In the past, when signals were so negative, there usually was a clearer story to tell.”

Venturing into a number of possible explanations, the article ended with a gloomy challenge to investors: “Determine whether the stock market moves… represent the rational kind of fear or the irrational kind of fear,…we probably won’t know the answer anytime soon.”

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E-mail: satur.ocampo@gmail.com
Published in The Philippine Star
January 30, 2016

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