The world’s stock markets are stumbling. By the night of Monday 24 August, the main US and UK indices had lost about 10 per cent of their value in the space of a week. On its own, that’s nothing too special. Stock markets are volatile. They hit air pockets of similar magnitude in, for example, 2011, 2012 and 2013. But the suddenness of this synchronised collapse, with most of the damage done in just a couple of days, is making everyone nervous.
What has caused this abrupt stalling of the engines in the world’s financial centres? The immediate culprit seems to be the stock-market blow-up in China. The collapse of the Shanghai bourse over the past weeks has been twice as bad as those of London or New York – and it came on the heels of a 20 per cent drop already suffered since June.
China being China, the government tried to arrest that crash in early July by banning the selling of some shares and spending public funds on buying up others. For a few weeks, it seemed to keep the lid on things. But when the cost of the intervention programme began to get frightening – there are rumours that $200bn have been thrown at the problem so far – even the deep-pocketed Communist Party of China blanched. The government buying stopped. The sellers are still there.
The Chinese stock-market bust should perhaps not have come as such a surprise. Plenty of other prices around the world have been sliding since the beginning of the year. The currencies of major emerging economies such as Turkey and Brazil have lost between a fifth and a quarter of their value against the dollar. A barrel of oil is a third cheaper than it was last New Year’s Eve. Even gold and silver, supposedly safe havens in a storm, have fallen this year.
That there are so many tumbling prices suggests there is something more to what is happening than just panicked stock jocks in Asia setting off their counterparts in Europe and the US. Indeed, when we turn from the flighty gyrations of the markets to the more ponderous evolution of macroeconomic indicators such as tax revenues, unemployment statistics and growth rates, an unsettling picture of fundamental economic weakness emerges.
In China, the investment-driven economic model that delivered 10 per cent annual growth rates in the early 2000s has run out of steam. It was prolonged into the 2010s by an unprecedented post-crisis government stimulus; but, as a result, China has piled up a mountain of debt to match the worst offenders in the developed world. The performance of the advanced economies has also been lacklustre. The eurozone has flirted with recession. The US economy has been in relatively good health – but there have been hiccups, too, such as the contraction in the first quarter of this year.
So the big question is not why stock markets have suddenly begun to struggle but why they have been doing so well for so long. Between the end of March 2009 and the end of June 2015, the US economy grew in cash terms by over 24 per cent. The value of the Dow Jones industrial index increased by 130 per cent. The $530bn question – that being the value wiped off the Dow by the recent reversal – is: why?
The answer is simple but ultimately paradoxical. It is that governments throughout the developed world have been so willing to support their economies with loose monetary policy. There was a brief moment in 2009 when fiscal stimulus (special tax breaks and temporary spending increases) was deployed as well. Yet mainly it has been central bank policy – low interest rates and, when they hit zero, quantitative easing – that has been the instrument of choice.
In the heat of the crisis, flooding the markets with cheap dollars, euros, pounds and yen successfully stemmed the market panic. With the incipient recoveries of 2009-2010, the policy even seemed to be reviving the real economy. Investors quickly re-established the habitual relationship between real economic data and financial prices: as the statistics showed economies gaining strength, optimism grew, the need for stimulus dissipated and prices rose.
Then the eurozone crisis came to a head and the US and UK turned out not to be growing as fast as expected. Investors concluded that more stimulus must be needed – lower interest rates, more QE. An unhealthy relationship developed between policymakers and the financial markets. Whenever economic data improved, markets sold off, because policy might one day be tightened. When the data deteriorated, markets rallied, because it suggested that the era of cheap money would continue yet. Good became bad. Bad became good. Such is the topsy-turvy logic on which the longest bull market in a generation has been built. Investors ceased to focus on real economic activity and diverted their attention to the plans of central bankers. All that mattered for markets to thrive was that interest rates remained at zero.
To be sustainable, this reasoning rested on an unspoken assumption: that a sufficiently loose monetary policy is capable of generating real economic growth. The risk was always that belief in this article of faith would be tested and lost – that investors would decide that the world’s problems can’t be solved by low interest rates alone. In an instant, the logic that bad news is good news would be turned on its head. The old certainties would be restored and, indeed, redoubled. Bad news is bad news, because there is nothing that the current policies can do to prevent a collapse and no sign of new policies on the horizon.
It is too soon to tell whether we have reached such a crisis of faith. When we do, things will get much, much worse.
Felix Martin is the author of “Money: the Unauthorised Biography” (Vintage)
This article appears in the 26 Aug 2015 issue of the New Statesman, Isis and the new barbarism