The global equity sell-off that followed the recent volatility in the Chinese markets says more about the plight of the western economies than it does about China. To understand the significance of recent events it is necessary to take a broader view than most asset managers, says Daniel Ben-Ami
One of the few investment outcomes that is virtually guaranteed is that times of high volatility bring out the worst in market commentators.
This shortcoming was abundantly clear in the recent round of turmoil that started in China. Even those pundits who would probably struggle to locate China on a map felt free to pontificate. Stick a microphone in front of their face and they were sure to come up with some banalities. For example, established investors could lose out as a result of falling share prices or alternatively new investors could take advantage of buying opportunities.
Such analysts generally found it unnecessary to encumber their comments with facts. Few seemed aware that the fall in the Chinese stock markets had been preceded by a substantial rise. Nor did they generally realise that the central bank’s decision to devalue the renminbi followed a substantial appreciation of the currency.
They were also far too ready to simply assume that market volatility must signal Chinese economic weakness. They should ponder the quip from Paul Samuelson, one of the best-known US economists of the twentieth century, who joked that the stock market had predicted nine out of the last five recessions. Of course it is possible that there are underlying problems facing the Chinese economy but these have to be investigated rather than asserted.
Unfortunately the often poor understanding of China does not end with the vast army of rent-a-quotes which has grown alongside the Asian giant’s economic importance. Even those with a comprehensive and sophisticated knowledge of China sometimes make misleading pronouncements.
The fundamental shortcoming of much analysis is that it tends to take a blinkered approach. Essentially it looks at a market event – such as the recent China volatility – and asks what it means for investors. Typical answers might be that investors should take a more selective approach to Chinese assets or that recent market concerns are overdone.
Of course it is part of the job of asset management groups to give guidance to their investors and even potential investors. It is only right and proper that they should do so. The problems arise when those working within this particular framework are asked to draw more general conclusions about the state of China.
Reality is much more mediated than such approaches allow. In other words, the world is a more complex place with the connections between different developments often taking convoluted forms.
The tricky relationship between the financial markets and the real economy has already been mentioned. In China’s case it is clear that it is trying to negotiate a relative slowdown from its long phase of rapid catch-up growth to a more mature phase of development. It is aiming for an economy that is more based on high technology and more urbanised. It also hopes to allow the population to consume a greater share of economic output.
To put it another way, China is trying to avoid what is sometimes called the middle-income trap. It is no longer poor but it still has to negotiate difficult obstacles before it can become rich.
However, it is not at all clear how this transition relates, if at all, to the recent bout of market volatility. There are no easy answers to this question. It is one that demands in-depth investigation rather than sound bites.
Another key complexity, and one that receives far too little attention, is the interaction between China and the West. It is arguably this relationship, rather than developments in China itself, which explains the West’s panic reaction to recent Chinese volatility. The obsessive focus on China’s short-term market obscures the chronic weaknesses of the developed economies that date back as far as the 1970s.
Over the past 15 years the West has become ever more dependent on growth in China in particular and emerging economies more generally. Without China’s rapid economic growth the plight of the atrophied advanced economies would be even worse than it is today. Cheap Chinese goods and plentiful Chinese credit have played a key role in buoying up the developed world.
The specific context to the recent equity sell-offs is the West’s difficulties in weaning itself off extraordinary monetary policy and ultra-low interest rates. When quantitative easing (QE) was first introduced in response to the 2008-09 financial crisis it was considered a temporary measure. Yet, several years later, even the US and UK have not managed to overcome this form of monetary addiction. Although they have ceased making new bond purchases they have not yet reduced their stock of assets. Economic growth would no doubt look even more anaemic without this stimulus.
In the euro-zone’s case it has only recently started full-blown QE. Its economic plight is if anything even worse than that of the large Anglo-Saxon economies.
The panicky global response to China’s market gyrations is largely a symptom of the West’s own insecurities. No doubt China faces formidable challenges in managing its economic transition but the developed economies are fearful of sinking ever deeper into the mire.
Daniel Ben-Ami is deputy editor of IPE