Weekend Market Turmoil an Outcome of Nations’ Failure to Cooperate on Change in Economic Policy

Although they ended with still more losses, U.S. stock markets recovered partly Monday after a plummet to dramatic lows fueled by fears of a collapse in the Chinese economy. The shock experienced in recent days was predictable, writes Guardian economics editor Larry Elliot.

Of the volatility on Monday, The Guardian reports:

The Dow Jones Industrial average was down 200 points, or 1.2%, at 16,257 points at 1pm on Monday, a huge recovery from a more than 1,000-point (6%) drop as the markets opened. The S&P 500 and the Nasdaq also recovered to be down 1.1% and 0.55% after falling of 5% and 8% earlier.

However, while US markets recovered, those in most of the rest of the world suffered some of the biggest one-day falls so far this year, which greatly reduces the chance of the US Federal Reserve moving to increase interest rates in September, something that had been widely expected by economists.

Lawrence Summers, a former US Treasury secretary, said raising rates soon would be a “serious error”. “A reasonable assessment of current conditions suggests that raising rates in the near future would be a serious error that would threaten all three of the Fed’s major objectives: price stability, full employment and financial stability,” he said in an opinion piece for the Wall Street Journal. …

The oil price, which has already fallen dramatically, fell more than 5% to a 6-1/2-year low.

US tech stocks, including Apple, Facebook and Netflix, which had suffered bruising declines of as much as 14% in the morning, were in positive territory by 1pm.

Writing Sunday about the likely cause of the turmoil, Elliot pointed to China’s recent devaluation of the yuan, which led to “strong suspicions that China’s growth figures have been doctored to disguise a hard landing” and a corresponding drop in investors’ confidence in Chinese industry.

More generally, Elliot wrote that the “events of the past couple of weeks should come as no surprise”:

There have been more than 50 serious financial crises since the breakup of the Bretton Woods system in the early 1970s, and the world was due one. That’s because, as the US economist Thomas Palley has noted, the current economic model is “unchanged and exhausted”.

The reason the global economy hit the wall in 2007 was that it relied on the US as the consumer of last resort. But Americans could not consume more out of wage growth because real income growth was negligible. They borrowed to consume, relying on ever-rising house prices to keep themselves financially afloat. Then the real estate bubble burst and the sky fell in.

The post-crisis world doesn’t look that much different. Central banks resorted to quantitative easing in order to prevent the money supply shrinking. The Federal Reserve bought $4.5tn (£2.9tn) of assets in three phases of QE and will doubtless announce a fourth if a marked slowdown in activity threatens to intensify deflationary pressure. …

Consumers in the west are being encouraged, in most cases against their better judgment, to take advantage of low interest rates to load up on more debt. But memories of last time are still relatively fresh. China wants better-balanced – and slower – growth. Every country bar none thinks it needs to export more and is prepared to indulge in beggar-my-neighbour tactics to do so. This does not stack up. The model can only be kept going – just about – so long as interest rates remain at historically low levels and asset prices are kept buoyant through a constant drip-feed of QE. [Italics added.]

The crisis of 2007-09 was a lesson to policymakers that international policy cooperation was needed to increase global demand. It was a lesson that there needed to be higher investment in infrastructure and skills to raise productivity. It was a lesson that an economic model based on widening inequality was unviable. It was a lesson about the risks of uncontrolled capital flows.

“Clearly,” Elliot concluded, “the lesson wasn’t big enough.”

— Posted by Alexander Reed Kelly.