Trouble in the Markets
WHY YOU SHOULD CARE
The economic headwinds coming from China seem to have finally caught up with the U.S.
By Steven Butler
Maybe it was only a matter of time. China’s economic storm has finally blown into Wall Street, sending stocks into their steepest one-week dive since 2011, while oil has also hit the slicks — dipping below $40 a barrel for the first time in more than six years.
Yep, lots to worry about. Most know China has been slowing down, but the country’s recent decision to let its currency, the yuan, slide against the dollar in order to make exports cheaper looked like a desperate move that’s unnerved everyone. And it suggests the Chinese economy — the world’s second-largest — may be much weaker than officials there want to let on. Meanwhile, exporters in developing countries are getting creamed by sliding commodity prices, and they’ll have even more trouble repaying certain debts if their own currencies continue to weaken. Global banks, watch out!
What does that all mean for the U.S. economy? While it still looks pretty solid for now, there may be future headwinds for exporters and corporate America as sales weaken abroad. All of this is making the U.S. Federal Reserve’s decision on whether to raise interest rates next month — or even this year, as it says it wants to do — a really tough call. After all, long-term interest rates are in the toilet again, suggesting no one’s expecting much inflation or, unfortunately, economic growth ahead. Desperately needed: firepower, from somewhere, to get the world economy revving again.
Oil may have taken a steep dive this week, but if history is any guide, it will be back up again. In fact, experience suggests that the lower prices go, and the longer they stay there, the greater will be the eventual rebound. That’s because lower prices lead to fewer investments in finding more of it, creating an almost inevitable future gap between supply and demand — much different from today’s world. But just when it seems crazy to bet on black gold, the oil bulls are playing the market in a way that would make J.R. Ewing proud. In the first quarter alone, as prices hit lows not seen since the Great Recession, they poured almost $2 billion into one of the world’s biggest oil funds, nearly tripling its assets. Some of that investment has since flowed out again, but the smart money seems to be holding back, waiting for an even bigger score. As one trader puts it: “The downside is limited, and the upside is explosive.” Read more here.
Few prognosticators of China have accurately called the steep slide we’re now seeing in what was until recently a growth economy. One notable exception: Michael Pettis, the peripatetic Beijing finance professor who writes a widely read financial newsletter. While Pettis says China could theoretically have a smooth transition to a consumer-driven economy that powers strong growth, he fears that’s an impractical long shot. It’s tempting to talk about him as a dual persona — an indie music impresario-cum-global financial clairvoyant — but that would make things too simple. His budding worldwide fame comes courtesy of a piquantly dour take on the so-called “Chinese economic miracle.” As expressed in books, his blog, publications like the Financial Times and a newsletter peddled to select clients for thousands of dollars, the “Pettis hypothesis” is that China has greatly over-invested borrowed money — in factories, infrastructure and construction — leading to a painful reckoning. Read more here.
Once again, it seems like there’s economic trouble brewing in Asia, especially in South Korea. The country is buffeted on all sides these days, as China — its biggest export market — slows sharply and rival Japan shows renewed competitive strength around the world, a reflection of a plunge in its currency that gives it pricing power for the first time in many years. There are plenty of early warning signs that Korea’s much-vaunted economic growth model may not deliver as much in the future as it has done so successfully in the past, including a deflated appetite for the country’s tires, cars, high-def TVs and smartphones. Chalk the drama up to the South Korean squeeze. Read more here.