news

“The Fragility of the Global Economy”, an article by Dr. Leonel Fernández

August 31, 2015

Recently the New York financial markets were shaken when the Dow Jones Industrial Average fell 1,000 points before anyone could react, closing at a low of 586 points.

Although, later days saw a certain level of recovery, the volatility in stock prices of firms listed on that index continues, with investor anxiety on the rise and uncertainty plaguing the markets.

As a result of that collapse in the value of industrial stocks, financial
markets in the United States suffered losses worth more than $2 trillion, equivalent to 10% of their total value.

To appreciate the magnitude of these losses, consider that they are equal to the combined market value of the world’s principal firms, including Apple, Google, Facebook, ExxonMobil, and Walmart.

This collapse in the U.S. markets came, in turn, as a consequence of a nosedive in the stock markets at Shanghai and Shenzen, in China, in
what has come to be called the “Black Monday” of the Asian giant’s financial markets.

From November 2014 to June of this year, Chinese stock markets had seen a rise of 100 percent. So bullish was this market that it attracted investments from 90 million Chinese in their own country’s markets, despite having little to no preparation or academic training on how stock markets work.

Suddenly, however, this speculative
financial bubble burst: panic spread throughout the markets, and more than half of the 2,800 firms listed on the exchange proceeded to withdraw their stocks.

For China, this signified losses of more than $3 trillion, or some 30 percent of the market’s total value, at $10 trillion. These losses represent more than the entire value of the French stock market and approximately 60 percent of the Japanese one.

The fact that in just three weeks, the
world’s two main economies, the United States and China, have seen more than $5 trillion disappear from their capital markets, prompts an important question: Where is the world economy headed? Will there be a recovery, or are we headed toward a new and even deeper global recession?

The Chinese slowdown
In line with the assessment of several economists, the cause of the collapse in the Shanghai and Shenzen markets was the
recognition that for the year 2015, China would see its slowest economic growth since 2009, with GDP increasing by just 7 percent.

What has been established is that the value of the stocks were set high above the projections for economic growth and the profits generated by firms, which currently stand at a level lower than a decade ago.

The Chinese stock markets are now deemed to have been disconnected from the country’s economic reality,
leading to the inflation or overvaluation of stock prices that caused a speculative bubble to balloon. In the face of this situation, the Chinese government intervened by buying billions of stocks through intermediaries, lowering the interest rate, and devaluing its currency as a way to renew confidence in its markets and inject liquidity into the economy.

But the drop in the Chinese stock markets did not just impact the United States: the markets in Hong Kong, Indonesia,
the United Kingdom, France, Germany, and Spain were also hit hard, throwing into sharp relief the current interdependence and interconnectedness of markets in a globalized world.

Despite the fact that Chinese has seen spectacular economic growth for more than three decades—to the point of hearing analysts discuss the “Chinese miracle”—in recent times its economy has undergone a gradual process of deceleration, slowing from 12 to 7 percent
growth.

The authorities in the Asian country explain this by saying that what is currently happening is that China is seeing a change of paradigm: over several decades the country focused on stimulating a strong increase in investment, on developing the real estate market, and on orienting its production toward exports.

At this time, however, China is seeking to create a new development model based on four pillars: innovation for growth; the increase of
domestic consumption; the application of a less contaminating energy system; and the development of a massive and accelerated process of urbanization, as a way to achieve greater social equity.

In any case, these days what’s prompted the abrupt fall in the Shanghai and Shenzen stock markets has been the increased uncertainty over the future of the Chinese economy, the turbulence and volatility of financial markets, currency devaluations in various countries, and
the strengthening of the U.S. dollar.

Economic weakness
Over several years, China’s high growth rates became the engine propelling the progress of several emerging economies. Nevertheless, the slowdown of recent years has translated into decreased demand and, in turn, lower growth in those economies as well.

Owing to reduced demand in China, there has been a deep drop in raw materials or commodities prices. In
the case of oil, for example, after having reached a peak of $147 per barrel in June 2008, the price stabilized at an average of a bit over $100 a barrel, only to now plummet to beneath $50.

That has affected oil exporting countries, who have seen their economies nosedive, their unemployment levels rise, and their currencies wobble. But the same trend has also affected the prices of gold, silver, copper, iron ore, soy, and corn, to name just a few. All have dropped
significantly, prompting a weakening of economic performance among the countries exporting those products.

According to ECLAC reports, this year Latin America, having experienced a golden decade in terms of economic progress and social wellbeing, will see growth of just 0.5 percent, due to the dependency of the region’s main economies on commodities exports to the Chinese market.

In fact, Brazil has already entered a recession, with negative
growth of 1.9 percent in 2015. But this weakness is also being felt in raw materials exporters like Chile, Colombia, Peru, and Ecuador.

Uncertainty also plagues the economic and political future of the Eurozone, especially because of the acute sovereign debt crisis in Greece. Overall, Europe will grow 1.4 percent, and this fragile increase will in turn be possible solely due to a change in the political economy orientation, which has gone from extreme austerity, with
drastic cuts in public spending, to a monetary expansion, with the European Central Bank pumping more than a trillion euros into the markets.

Japan, despite the fiscal stimulus it has been applying, will see growth of just 0.6 percent. Russia—with the conflict with the Ukraine, the fall in oil and gas prices, and the sanctions applied against it—will see its GDP contract by 3.5 percent.

Only the Asia-Pacific region, with growth above 5 percent, Africa
with 4 percent, and the United States, projected in 2015 to grow at a rate of 2.9 percent, appear to have escaped the distress, confusion, and uncertainty that dominate the international scene.

Because in general the perception is that in the middle of financial turbulence on the world’s main stock markets, the drop in oil and other raw materials prices, the appreciation of the U.S. dollar, and the geopolitical tensions in the Middle East, the global
economy—rather than moving toward a full recovery from the Great Recession—seems to be headed for a new stage of enormous challenges.

At least, that’s what it looks like.