Exit bull, chased by Chi­nese bear

The Pak Banker - - OPINION - Manas Chakravarty

THE Win­ter's Tale con­tains Shake­speare's most fa­mous stage di­rec­tion: Exit, pur­sued by a bear . Is that what is about to hap­pen to the bull mar­ket, af­ter last week's blood-let­ting? And is this par­tic­u­lar bear Chi­nese? The big­gest re­cent shock to the mar­kets has been the Chi­nese cur­rency de­val­u­a­tion. It was rather small, as de­val­u­a­tions go, and the yuan is down a mere 2.8% from its pre-de­val­u­a­tion lev­els. Af­ter the ini­tial wob­ble, the yuan has held steady. The Chi­nese author­i­ties are spin­ning it as a one-off event and say they have no in­ten­tion of let­ting the cur­rency slide. Nev­er­the­less, it was a nasty sur­prise to the mar­kets and added to the fears that some­thing is rot­ten in the state of China.

The mar­ket has al­ways had a touch­ing faith in the abil­i­ties of the Chi­nese Com­mu­nist Party. Not with­out rea­son-it did turn the coun­try into an in­dus­trial pow­er­house within a cou­ple of decades. Its rise has been a great boon to a raft of com­mod­ity ex­porters. The strength of the Chi­nese mar­ket has been a life-saver for many busi­nesses. And the party's abil­ity to de­liver re­sults has led to the belief that it will be able to man­age China's dif­fi­cult tran­si­tion from an ex­port-driven and in­vest­ment-led econ­omy to one more re­liant on house­hold con­sump­tion with­out a hard land­ing.

But the de­val­u­a­tion and the ear­lier crash in the Chi­nese stock mar­ket have shaken that faith. In spite of throw­ing bil­lions of dol­lars at the mar­ket, in spite of curbs on selling, the Shang­hai Com­pos­ite in­dex is now a whisker above its clos­ing price on 8 July, im­me­di­ately af­ter the crash. Po­lit­i­cal prob­lems are mount­ing. Pres­i­dent Xi Jin­ping's crack­down on cor­rup­tion and re­forms have come up against "unimag­in­ably" fierce re­sis­tance by en­trenched in­ter­ests, ac­cord­ing to Chi­nese state media quoted in the South China Morn­ing Post. The cri­sis of con­fi­dence has led to mas­sive cap­i­tal out­flows from China. Ev­ery­one knows the course of true re­form never did run smooth, but the nag­ging sus­pi­cion that has now reared its head is: Has Xi lost the plot?

The cat­a­lyst for Fri­day's car­nage in the mar­kets was China's flash man­u­fac­tur­ing Pur­chas­ing Mangers' In­dex (PMI) for Au­gust, which came in at a 77-month low. This is the sixth suc­ces­sive month the in­dex came in be­low 50, which means the man­u­fac­tur­ing sec­tor is con­tract­ing. What's worse is that the pace of con­trac­tion speeded up in Au­gust. Four in­ter­est rate cuts since last Novem­ber and lower re­serve re­quire­ments for banks do not seem to have had any im­pact. Chi­nese growth is im­por­tant sim­ply be­cause in these "new medi­ocre" times since the fi­nan­cial cri­sis, China has con­trib­uted about one-third of the growth in world gross do­mes­tic prod­uct. With growth hard to come by these days, China was a bea­con of hope for the world econ­omy. Many coun­tries, rang­ing all the way from Aus­tralia to South-East Asia to Brazil, will see slower growth now that China is de­cel­er­at­ing. Small won­der global mar­kets are cry­ing plain­tively, "Et tu, Xi?"

In­creas­ingly, the worry is that na­tions will turn to cur­rency wars to prop up growth. The Chi­nese de­val­u­a­tion, mod­est so far, has al­ready led to a wave of cur­rency de­pre­ci­a­tion among emerg­ing mar­kets. If we look at the flash PMIs, we'll see that growth has ac­cel­er­ated in the euro zone and in Ja­pan, the two re­gions that have been able to weaken their cur­ren­cies sub­stan­tially. In the past year, the euro is down nearly 14% against the dol­lar, notwith­stand­ing its re­cent sharp move up. The Ja­panese yen has de­pre­ci­ated by nearly 15% in the past year. On the other hand, the US is be­ing hurt by the strong dol­lar, as seen from the Au­gust flash US man­u­fac­tur­ing PMI, which has dropped to the low­est level since Oc­to­ber 2013. So far, all we've had are cur­rency scuf­fles, but it will take lit­tle to cry havoc and let slip the dogs of cur­rency war.

Will the crack in the mar­kets deepen? The US Fed is un­likely to take kindly to any ma­jor dis­rup­tion in the mar­ket. Af­ter all, in­creas­ing as­set prices in or­der to stoke the wealth ef­fect has been an ex­plicit ob­jec­tive of the Fed. Re­call that the down­turn in US mar­kets last Oc­to­ber dis­si­pated as soon as Ja­pan an­nounced another dose of quan­ti­ta­tive eas­ing. Any se­ri­ous cracks will see cen­tral banks leap once more unto the breach with pots of money, never mind that it will in­flate the global liq­uid­ity bub­ble, al­ready enor­mous. But any re­bound will not al­ter the fact that the old global growth model, with US debt-fu­elled con­sump­tion and Chi­nese debt­fu­elled in­vest­ment as its twin driv­ers, is bro­ken and no amount of throw­ing around cen­tral bank money is go­ing to mend it.

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