China Stock Market Crash. What are the implications?

Aside Posted on

The big crash, or a dress rehearsal for the next big one?

Playing word association, one easy response to the phrase ‘stock market’ is ‘crash’. Stock markets frequently crash because they are not barometers of economic health but are really a measure of how much the financial sector thinks it can skim off the rest of society at any given time. As a result, they subsist on fear and greed.

What lies behind the bursting of stock market bubbles around the world is the response to the global financial crisis. ‘Quantitative Easing’ has been in the news recently. When the central banks in the US, UK and the Eurozone pumped hundreds of billions of dollars, pounds and euros into the banks it was another form of bank bailout. In exchange for low-yielding government debt they were holding, the banks were handed huge amounts of cash (electronically).

But instead of using this to fund investment in the economy, in sectors such as transport, energy, infrastructure and house building, the banks used it to fund speculation in stock markets, in commodities and in house prices.  They encouraged borrowers to do the same and the supposed ‘feel-good factor’ when these bets were winning ones funded increased consumption. This was how the Tories got re-elected.

By contrast, in China they increased investment during the global recession, and avoided a domestic recession altogether. The problems for China and its stock market bubble arise because since 2012 policy has become a bit more Westernised, pro-market, lower investment and higher consumption.

Across the world those bets have now gone spectacularly bad as stock markets and commodities prices have plunged.  The driver of this fall is the expectation that the US central bank was poised to raise interests in September.

This doesn’t mean that a recession will automatically follow. Even an old stock market adage is that they “have forecast seven out of the last two recessions”. That is when the fear overwhelms the greed but there is no serious economic consequence.

It now seems much less likely that the US central bank will be raising rates anytime soon. In fact the Federal Reserve has become notorious for attempting to ensure that stock markets do not fall and adjusting interest rates accordingly. That thinking could kick in again, and their hope will be that the bubble can be gently deflated.

This benign scenario is extremely unlikely. Either the Federal Reserve will raise interest rates and so damage the Western economies where growth is currently at a snail’s pace and the banks remain extremely fragile. More probably, they will postpone interest rates once more, and try to reflate the bubbles.  This could postpone the next the next slump in the real economy. But it only means that the eventual crash will be even more dramatic.

Michael Burke Economist

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