China’s fall hasn’t changed everything – it’s really just noise

The market system is pretty robust – you get big swings and we live with them

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The Independent Online

It is back to school time – and to a rather different economic landscape from that of the first week of August. Share prices on the major world markets are around 10 per cent lower than they were three weeks ago, with the FTSE 100 index back to the levels of early 2013. But that is just the start of it. The so-called “fear index”, the Chicago Board Options Exchange’s volatility index or Vix, doubled in one week last month. Suddenly everyone is worried about China’s economy slowing down, just as we used to be worried about the reverse: China’s growth scooping up all the world’s resources. All this has led to suggestions that the Federal Reserve will postpone its long-awaited increase in interest rates, a case of the Chinese tail wagging the US dog. For those few people who don’t catch up with the news over their holiday it must all come as a bit of a shock.

But are things really so different? Common sense says they can’t be. The world economy does not change in three weeks. The data coming out remains reasonably upbeat: good eurozone job numbers yesterday, decent expectations from German industry, and signs of solid consumer demand in the UK. There may be some slackening of growth across the developed world, and British exporters have been hit by the stronger pound, but there is nothing happening that you would not expect to happen at this point of the economic cycle. How then can you explain the sudden change of mood – and does it matter anyway?

There is a simple explanation, and a rather longer one. The simple explanation is that this is mostly a stock market thing. You often get sharp reversals in financial markets after they have had a long bull run. The world’s investors feel they have done well, values are pretty high by historical standards, and so it might be time to take a more cautious position. There are the further complications of the looming rise in interest rates and the suggestion that the Chinese authorities have lost control, but they are really excuses for the fall in Western markets, rather than direct causes of it.

That may be all it is, and it is easy to think of market reverses in the past that would conform to this. But there is a longer and less encouraging explanation, which goes roughly like this. There is a global economic cycle, with periodic reverses that the policy-makers have to cope with as best they can. It would be great to eliminate the cycle – to end boom and bust – but we can’t and people who say we can end up with egg on their face. All we can do is to try to minimise its amplitude so that it is less destructive of jobs and economic activity more generally, and that is what sensible policy aims to achieve.

The trouble is that the efforts to lift the developed world economies, in particular very loose monetary policies, have been only partially effective in generating growth and have had serious side-effects. They have punished savers, rewarded owners of assets, and increased inequality. We are six or seven years past the bottom of the economic cycle, so on historical averages, another dip ought to be coming fairly soon. But interest rates are still on the floor and most governments, including our own, still have some way to go to get their budget deficits back under control. So the markets, in their incoherent way, are reacting to the possibility that, come the next downturn, the authorities won’t have much ammunition to fire when they try to lift things up. The fact that China appears to have been unsuccessful in combating the slowdown there has been the new factor supporting this more pessimistic outlook, hence the market declines there leading to something of a global meltdown.


The rather glum conclusion here would be that there will, maybe not now but in the next couple of years, be another global economic downturn, and when it comes there will be very little the powers that be can do about it.

Whichever explanation you prefer, and of course there will be some merit in both, the fall in the markets is a fact. Does it matter?

The best answer to that is: not in itself. For all its faults, the market system is pretty robust. You get big swings and we live with them. The oil price has halved and that has caused problems as well as bringing benefits. Yet the big oil companies seem to be managing all right. The big banks are much more cautious now than they were eight years ago, and for good reason. So they will not be greatly affected by market turmoil. As for the direct impact of the bear market in equities, the falls will have damaged some of the pension funds, but less than it might have done a few years ago when they were more heavily invested in shares. (Mind you, that switch means that the funds did not benefit as much as they should have done by the boom of the previous three years.) 

Besides, while there are signs in some markets – hi-tech shares in the US, for example – of the sort of frothy, speculative conditions that have flashed red warning lights in the past, there is not the widespread euphoria that typically comes ahead of a big economic downturn. Naturally if the present market unease gets worse, then it will undermine the real economy. But we are a long way from that.

If this argument is right, then what we are seeing is actually quite healthy. It grounds people. It stops the business and financial community getting carried away with its own cleverness. You often get a mid-cycle pause in growth and we may well get one soon. But that would not mean that growth is over and the next world recession is upon us. Even the undoubted slowdown in China is generally welcome as it takes pressure off the resources of the world economy.

I think the underlying point here is that the world economy is not a homogenous entity, marching forward in unison. There always will be parts that are racing ahead and parts that are lagging behind. That is clear here within the UK, so how much more so internationally? If the whole entity moves forward a bit more slowly, then the march may go on for longer.