The cur­rent global fi­nan­cial cri­sis

Financial Mirror (Cyprus) - - FRONT PAGE -

Dur­ing the last month, global mar­kets have been roiled by the fi­nan­cial cri­sis that em­anated from China, but prop­a­gated to other parts of the world. To put things into per­spec­tive, dur­ing the month of Au­gust more than $5 trln has been lost from global eq­uity val­ues amid fears that the growth rate and prospects for the world’s sec­ond largest econ­omy, China, are worse than pre­vi­ously ex­pected. On top of that, the US Fed seems to be ready to raise in­ter­est rates (ei­ther in the Au­tumn or early next year) af­ter many years of a low in­ter­est-rate en­vi­ron­ment, de­spite the slow­ing global eco­nomic growth.

Some ar­gue that the cur­rent cri­sis is rem­i­nis­cent of the East Asian cri­sis of 1997 that started from Thai­land, and spread quickly to other East Asian tigers such as In­done­sia, Malaysia, Philip­pines, and South Korea. Cur­ren­cies and stock mar­kets plunged across the re­gion, even in places as far as Latin Amer­ica, threat­en­ing a global re­ces­sion. So, how did this cri­sis start and what are the fun­da­men­tal rea­sons be­hind it?

Chi­nese stock mar­kets and its bench­mark, the Shang­hai Com­pos­ite In­dex, have been ris­ing rapidly in the last few years, with some fear­ing that it was a bub­ble about to burst. This in­dex peaked by mid-June and then be­gan to fall at an ac­cel­er­ated pace. In an ef­fort to save the cap­i­tal mar­kets, the gov­ern­ment used ag­gres­sive tac­tics such as ban­ning short sales, stop­ping ini­tial public of­fer­ings, pro­hibit­ing the sales of shares by all ma­jor in­vestors, and in­struct­ing state-owned funds as well as in­vestors to buy up shares to raise prices. Then, in an un­prece­dented move just prior to the open­ing of the mar­kets on Au­gust 11, the Chi­nese cen­tral bank de­cided to de­value the yuan by around 2% against the dol­lar and thus de-peg it from the US cur­rency. Only two days later, Chi­nese of­fi­cials de­cided to re­verse this de­ci­sion and halt the de­val­u­a­tion by in­ter­ven­ing in the cur­rency mar­kets when needed.

Since then, they spent al­most $200 bln in cur­rency mar­kets to halt this de­val­u­a­tion that they started. The Chi­nese mar­ket has also lost around $4.5 trln since the peak of the mar­ket in early June.

The shocks from China did not go un­no­ticed in other places around the world, with stock mar­kets tum­bling one af­ter the other. Just in the US, more than $2 trln in value has been wiped out from stock mar­kets in the last month, while the MSCI All­Coun­try World In­dex dropped 6.5% in Au­gust, its big­gest drop since May 2012. The beg­ging ques­tion of course is what are the fun­da­men­tal rea­sons be­hind this cri­sis?

Cer­tainly, one rea­son be­hind the cur­rent cri­sis em­a­nat­ing from China is the re­al­i­sa­tion from global in­vestors that the growth in the Chi­nese econ­omy is slow­ing down. The growth of China’s GDP of 7.4% for last year was the slow­est in the last 24 years, while the ex­pec­ta­tion is that this year China will not be able to achieve its tar­get of 7%. At the same time, in­vestors seemed to lost faith in the in­co­her­ent pol­icy ac­tions of the Chi­nese of­fi­cials, given what has hap­pened in the last month.

Fur­ther­more, given the re­cent good US eco­nomic con­di­tions, US of­fi­cials are poised to raise in­ter­est rates soon (the first time since 2006) fear­ing fu­ture high lev­els of in­fla­tion af­ter years of mon­e­tary eas­ing. This ex­pec­ta­tion puts more pres­sure on global eq­ui­ties, and that is why we have been ob­serv­ing a move­ment of in­vestors to safe havens, i.e. away from the dol­lar and mov­ing to the euro and the yen, as well as to safe Trea­sury se­cu­ri­ties (this is de­scribed as “flight to qual­ity”).

Lastly, some ar­gue that what we have been ex­pe­ri­enc­ing these days is a cor­rec­tion of prices, i.e. eq­uity prices around the globe were in­flated, and now in­vestors are mov­ing the prices back to their fun­da­men­tal value.

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