The selloffs in the major global stock exchanges as well as the collapse of commodity prices like copper and oil have continued into the second week. The fact that all this can be linked to one country, China, is beginning to make many market observers and indeed the general populace wonder: are we back to the 2008 scenario all over again?
The similarities are too striking to ignore. In 2008, the trigger for the global financial crisis was the collapse of the subprime mortgage market in the United States. Banks such as Bear Stearns and Lehman Brothers, which were heavily exposed to the toxic credit default swaps and other CDO instruments tied to this market, ultimately collapsed one after the other, triggering a massive global selloff as sheer panic seized the markets. Were it not for the intervention of the US government in the form of the Toxic Assets Relief Program (TARP) as well as various stimulus packages put in place by central banks across the globe, many more companies would have been forced to close down and the entire global financial system would have completely collapsed.
Fast forward to 2015. The world’s markets had been on a massive bullish run for close to three years and 2008 seemed a very distant past. Then the warning signs began to show in China. Just like many governments and businesses from all over the world were exposed to the US subprime mortgage market either via direct investment into the properties whose prices peaked and began to drop, or indirectly to the credit default assets based on these real estate assets, so also are many countries heavily exposed to China. China has massive investments in Africa. China accounts for 40% of the world’s production and requires the importation of large amounts of copper, gold, crude oil and other raw materials to feed its industries. So many countries have found themselves heavily dependent on China to drive their economies and sustain the value of their currencies. The 2008 experience which saw a localized problem in the US take on global dimensions, seems to have reared its head once more with a localized problem in China also assuming global significance.
The Chinese Connection
How did China start to impact the global markets negatively in recent times? One explanation is the consumption pattern of the products of the Chinese industrial revolution. China has a population of about 1.5billion people, but most of the products of Chinese industries are shipped abroad and do not serve this large local market. The dangers are obvious. When demand from the foreign markets starts to drop off for any reason, the Chinese economy also suffers. This has been the case for the last three years. Chinese GDP had hit a high of 14.2% in 2007, but over the last three years has drifted between 7.7% and 7.4%. This year, the central government in China identified as one of its development goals, the attainment of a GDP driven by a sustainable growth model, with an increase in local consumption of the output from Chinese industries. In pursuance of these goals, a GDP target of 7% was set in pursuance of these goals. However, a number of issues have cropped up within the Chinese economy which have not only made this GDP target seem at best too optimistic, but have also begun to threaten the global market as well.
- By the middle of the year, the Chinese stock market, which had on a two-year bullish run, began to show signs of a market bubble as uninformed investors among the general public poured into the market in droves. Despite the warnings by regulators, the influx of retail money into the stock market continued until the market corrections started. At a point, the Shanghai stock exchange plunged 11% in a single trading session, sending jitters around the financial markets. The central government tried a number of moves to support the market; getting listed companies to suspend trading in their shares and buybacks of stocks of companies, but nothing has worked. It now seems the authorities in China have thrown in the towel and are letting market forces fully determine the value of the Chinese stock market.
- Manufacturing has taken a big hit in China. The Flash PMI data which was released in the second week of August 2015 has shown that the Chinese economy is not just contracting, but may actually be on track to missing the 7% GDP target. This is bad news for commodity exporters to China such as Zambia, which makes 70% of its revenue from copper. Australia, which supplies a large chunk of raw materials and commodities used by Chinese industries, has also taken a hit and this has impacted the Australian Dollar negatively. This has sent commodity prices of commodities reeling.
- Faced with the scenario of not being able to meet GDP targets, the People’s Bank of China devalued the Chinese Yuan between August 11 and August 13, 2015 in a knee-jerk attempt to cheapen Chinese exports and drive export sales upwards. Whatever the intention, global markets reacted negatively to the news with Asian currencies plunging and stock markets across the world experiencing steep losses.
- The shale production in the US has already created a massive glut in the market, with latest data showing that there are roughly 2 million barrels per day more than market demand. With sanctions now lifted on Iran, the market is also bracing up for the addition of more oil to the market, which will further dampen prices. Oil is now trading at six-year lows.
The negative impact of exposure to China is now beginning to show in all asset classes.
Stock markets across the world have been falling systematically. On Monday August 24, 2015, the Indian stock exchange fell by the most it has fallen in seven years, the Dow closed 588 points lower to mark its worst day of 2015, and European markets fell by about 5%. This is in addition to the steep losses sustained the week before.
Hardest hit in all this are the emerging market currencies. These have been under pressure from the possible interest rate hike which the markets are expecting from the US Federal Reserve before the end of the year. The South African Rand plunged to is lowest level ever against the greenback, hitting 14.000 on Monday August 24, 2015. The Rand has been under pressure all year from the US rate hike expectation as well as several monetary policy decisions by the South African Reserve Bank.
Several Asian currencies have also been affected. The Kazakh Tenge plunged 22% on Thursday August 20, 2015 as the Kazakhstan Central Bank abandoned futile attempts at defending the currency. The Vietnam Dong, Turkish Lira and Brazilian Real have also lost ground against major currencies. The Malaysian Ringgit, Zambian Kwacha and Nigerian Naira have also suffered depreciation as a result of falling commodity prices and the Chinese Yuan devaluation which has made Asian economies in unable to compete favourably with China in certain trade sectors such as the textile industry.
The slowdown of the Chinese manufacturing sector has hit countries that export raw materials feeding the Chinese industries particularly hard. Copper and oil prices have fallen steeply since the last year, and gold prices have also not been spared.
The volatility in global markets will no doubt provide good trading opportunities for informed investors. As the world watches the unravelling of markets, the question is: have we all learned any lessons from 2008? After now, will the world transit from overdependence or overexposure to one economy, or will changes be put in place? The world waits.