Back in July I posted an article regrding the potential problems in China and now it would seem a fairly good time for an update.....The question being is the China effect merely 'transient contagion' as some would have us believe? Should we buy the argument that the Chinese stock market is unrepresentative of the real state of the country's economy, that it is totally detached and the plaything of ill-informed, mischievous speculators? The answer is simply.….NO!
Call it financial crisis, an economic crisis, a political crisis or a crisis of confidence. Call it whatever you want or all four, but it is something our financial and political leaders are still reluctant to admit.
It is there for all to see who are willing to open their eyes, recession and deflation are back to haunt us. There is nothing to be optimistic about. Blame China, blame the Fed, blame commodity oversupply, blame the Eurozone, Russia, Brazil, QE, austerity, an aging population, low productivity, terrorism, geopolitical tensions or social media. Blame whoever or whatever you want, what is relevant now is what is to be done
Whichever side you are on the China question, there can be no denying that the commodity price collapse risks driving emerging market economies into recession. The problem is that the negative impact of the price fall is immediate whereas the positive impact is much slower to bear fruit and emerging market economies and the global economy are not strong enough to wait.
Over the last decade emerging market foreign and local currency debt has risen from $5.4 trillion to $24.4 trillion, or 90% of GDP according to the International Institute for Fiscal Studies. Within this, foreign-denominated debt has risen from $900 million to $4.4 trillion. As local currencies weaken, the foreign burden escalates, which is why everyone is so concerned about the impact of a Chinese devaluation.
Where China goes with its currency, emerging market export competitors are forced to follow. As the burden escalates and the risk of corporate defaults continue to loom, badly needed capital exits the country at the very moment it is most desperately needed. Even local debt becomes a problem as growth weakens and banks run out of funding options to roll over loans.
When China sneezes resource dependent emerging market economies that are already on their knees, and in some cases in political crisis, risk catching pneumonia.
In this globalized world, if emerging markets catch pneumonia, then Europe and the US risk catching flu at the very least.
Can the U.S. really get through a contagion unscathed? I seriously doubt it, unless the Fed can engineer a meaningful drop in the U.S. dollar.
It doesn’t help when you can see that since 1960, whenever industrial production growth has fallen more than 0.25 percentage points below zero, we have either been in recession or a recession has ensued in a matter of months.
Given the troubling signs from numerous market indicators, I doubt that “this time will be different.” The global economy has become increasingly reliant on higher levels of debt to generate each dollar of incremental GDP.
Standard and Poor’s reported last week that the health of indebted companies globally had deteriorated at its fastest rate since 2009. At the moment, problem borrowers are concentrated in oil, gas, metals and mining but there are signs of contagion. The agency says that the decline in the financial health of businesses in the second half of 2015 is the most rapid in six years. Moreover, worsening credit markets continue to warrant extreme caution. The outlook for corporate credit is the worst since the financial crisis. The proportion of issuers facing a potential downgrade exceeds possible upgrades by the most since 2009, according to a January 6 Standard & Poor’s report (https://www.globalcreditportal.com/ratingsdirect/renderArticle.do?articl...).
The gap also widened the most in the past six months and corporate defaults have risen to the highest since 2009.
The oil price collapse in particular has unsettled the markets.
The tentacles of the oil industry are far and wide and the implications are in many cases only just sinking in.
The collapse is turning into a catastrophe. The oil industry is a massive direct source of employment and investment. Indirectly there will hardly be a manufacturing or service sector that is not or will not be affected negatively by what is taking place, at least in the short term. Environmentalists might be smiling but low oil prices are bad news for their cause and for investors in the renewables sector. Put simply the oil price collapse to below $30 bbl is destabilizing for everyone. If the mighty oil industry can be brought to its knees then any industry can......
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