By Nikola Kedhi
January has been a bloodbath for stocks and commodities everywhere. Oil has been plunging with an unprecedented speed, while China’s precarious situation unsettles even the most optimistic investor. A wave of theories, hypothesis and predictions has been sweeping the markets in every country, with analysts trying to answer one question: are we nearing a new financial crisis?
George Soros — nicknamed the man who broke the Bank of London — had a warning to deliver a couple of weeks ago. According to him, global markets are facing a crisis similar to the 2008 one. He blamed the current situation in China, stating: “China has a major adjustment problem. I would say that it amounts to a crisis”.
When you look at the markets nowadays, it seems that Mr. Soros may be right. Since the first day of trading this month, stocks have been declining on a daily basis. On Wednesday, the FTSE 100, Japan’s Nikkei Index and Topix Index entered a bear market, meaning that they fell 20% from their peak levels. European stocks declined to a 15-month low, with the Stoxx 600 decreasing 3.2% on the same day. A similar situation unfolded in China: the Hang Seng China Enterprises Index closed 4.3% lower. Overall, global stocks have plunged to their lowest levels in two and a half years. Thus, at first glance the picture looks very pessimistic.
On the other hand, there are also investors, analysts and CEOs who do not see only doom and gloom. In an interview with Bloomberg, Evercore CEO Ralph Schlosstein was confident that the real economy will eventually calm the markets. He said that the main world economies have been growing these past few years, although slowly at times. Volatility will be present because there is uncertainty about oil and China’s sluggish economy. However, if we analyze these two sources of unease, we can also make a forecast on the future of the markets.
Martin Wolf — chief economics commentator for the Financial Times — argues that we should not worry about the market turmoil in China. The real problem is the Chinese economy. Until now, China has relied on huge investments, low cost manufacturing and lots of exports. Currently, it has reached a point where this model does not apply anymore. Investments have been declining, and with them demand for commodities and other assets. All the while, government debt has been increasing, with debt-to-GDP ratio rising 50% in the past 4 years. For approximately a year now, China has shifted its attention towards real estate and financial services. The government has made some positive steps toward a liberalized market, yet there is still a long road ahead before the Chinese markets are considered free. The turmoil in China is a reflection of the shift in the economy described above. It will take a long time before the situation stabilizes.
These internal struggles in the Chinese economy are being felt in nearly every financial market. Energy prices have declined partly because of the decrease in the Chinese demand, which makes up a huge part of the world demand. The growth rate (6.8%) has plunged to the lowest levels since 2009. China needs substantial reforms, especially in the financial sector. Freeing capital flows, increasing privatization and more autonomy and transparency for market participants are fundamental if China wants to stabilize and remain competitive in an ever-evolving financial world.
Oil this week fell below $30 a barrel for the first time in 14 years. There are two factors causing this rout in oil. First, there is an oversupply in oil. OPEC remains steadfast in proceeding with pumping more oil. Now that the sanctions are lifted, Iran has also returned to the fold and it is expected to supply the commodity. When the news about Iran broke, oil fell to $29 a barrel. At the same time, China’s situation has caused a decline in the demand for oil. A barrel costing $20 now seems an inevitable scenario. However, most economists expect oil to return to the previous trend of increasing prices in the middle and long run.
Thus, the situation today and the one in 2008 are very different from one another. Even though China is experiencing a turbulent situation, the US economy has been faring very well. It has full employment levels, stable financial conditions and is expected to continue with the rate increases. The EU is still recovering, albeit at a sluggish pace. Nevertheless, European economies have been performing quite decently, maybe with the exception of Greece.
Speculators who bet on the price movements of stocks, often warn of imminent crisis. They know investors will listen when they speak, so they attempt to influence the price movements themselves. Occasionally they are right, many other times they are not.
In all cases, the most important thing is to look at the different economies, analyze their state, and make the right comparisons with historical counterparts. That is the only way to forecast and prevent a financial crisis. Right now the source of the upheaval is China. As the World Bank said a few months ago, the solution is fundamental reforms in the Chinese economy and market.