By Andrew Sheng
Special to Asia
As Asian corporate and finance leaders have returned from their annual binge at the Davos World Economic Forum to alarm bells ringing in global financial markets. Warning signs suggest 2016 is on the brink, with the Dow Jones Index losing 11 per cent since January 4. The worry is all about crashing oil prices, China slowing, Islamic State bombings, European migration and slowing global growth. At the same time, confidence in political leadership has been shaken by Donald Trump’s rabblerousing remarks in the run up to the US presidential elections.
Stealing the headlines from Davos was an Oxfam report revealing that the “62 richest persons own more than half of the world’s population”.
It went on to suggest that “if $7.6 trillion of individuals’ offshore wealth can be taxed, governments around the world would get at least $190 billion annually to address inequality”.
However, since quite a few Davos delegates manage money for the rich, global inequality was never really high on the agenda.
Is the world teetering on the brink of a bear market or a recession?
There is no question that risks are growing, because too many factors are changing at the same time. Global financial markets have been propped up by massive unconventional monetary policy and negative interest rates, with unprecedented bull markets in equity, bonds, real estate and commodity prices. Hence we should not be surprised if these bubbles deflate when the two key drivers of prosperity in the last five years are signalling “normality” – the Fed on interest rates and China on GDP growth.
Markets are driven by greed and fear. We have had our greed binge, so fear is now being fed by news that everything in China must be bad and that oil will dip further to $20. In the late 1990s,a former Brazilian central bank governor reminded global bankers and fund managers that if they speculated on the Brazilian currency too much, what they won on their “short” positions would be wiped out by losses on their Brazilian loan books. The tail of financial markets is still driving the real economy.
The psychology of markets is such that fears are often self-fulfilling. The market fear on lower oil prices is actually over-blown. In case anyone forgets, low oil prices are very good for the average consumer and industrial energy users. China, India and Japan all benefit, as do consumers. The latter, however, may not necessarily be willing to spend at the moment, because many of them are also worried about their jobs. We should worry more about running short of drinkable water than running short of oil.
The other puzzle about the whole growth-and-deflation story is that in the US and China, job numbers are holding up very well.
In the US, employment in the services sector, which accounts for 86 per cent of American jobs, increased by 2.3 million last year – which is one reason why the Fed finally raised interest rates.
In China, unemployment has been flat at 5.1 per cent, because the labour force shrank by 4.87 million due to retiring workers and the return of migrants back to inland provinces. The labour shortage is holding up wages and, in turn, internal consumption. The fact that the economy has slowed, yet unemployment has not shot up, is a good sign that productivity adjustments are being made.
What spooks fund managers about China is the direction of the renminbi. There are two possible explanations for what has happened with the People’s Bank of China’s renminbi operations since last August. One is that in line with the currency’s internationalisation and IMF expectations it will become freely usable as part of the Special Drawing Rights basket, the central bank is moving towards using a basket of currencies (as yet undisclosed) as a benchmark for the renminbi. The second is that the central bank’s policy is geared towards a depreciation against the dollar, but stability against the benchmark basket. What happened in the confusion is that the market simply did not understand the central bank actions.
As former US Fed chairman Ben Bernanke noted in his book “Courage to Act”, until recently, central bank operations were shrouded in mystique and secrecy, the rule of thumb being 1930s Bank of England Governor Montague Norman’s dictum “never explain, never excuse”.
This policy was effective at a time when the economy and financial markets were relatively closed. But in today’s dynamic financial markets, central bank transparency is a must. The global market turbulence when the renminbi moved only 1.9 per cent last August demonstrated that even with a closed capital account, renminbi internationalisation is already a fact, not a distant aspiration.
My worry is less about the real economy and more about how fund managers are psyching themselves and millions of ordinary (“retail”) investors into panic, which has the risk of being self-fulfilling. As one fund manager put it recently, “it’s time to get out of the water”.
One reason why retail investors should get out of the water is because there are too many sharks.
A joke doing the rounds in Hong Kong and Wall Street: fund managers don’t eat shark’s fin soup – not because they care about the environment, but out of professional courtesy.
Caveat Emptor – or in this case, investor beware!
Andrew Sheng writes on global and Asian financial affairs.